Keurig Dr Pepper Inc (KDP) 2016 Q2 法說會逐字稿

Good morning and welcome to Dr Pepper Snapple Group's second quarter 2016 earnings conference call. Your lines have been placed on listen-only until the question-and-answer session. Today's call is being recorded and includes a slide presentation which can be accessed at www.drpeppersnapple.com. The call and slides will be also 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 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. Once again, we posted another solid quarter as our teams continued to relentlessly focus against our strategy. We're on track with driving integrated communications and execution across our priority brands and RCI continues to permeate throughout the organization and drive sustainable financial benefits.

For the quarter, bottler case sales increased 1% on almost 4 points of positive mix and price. Volumes grew across our portfolio with CSDs increasing by 1% and non-carbs increasing by 2%. Brand Dr Pepper decreased 1% in the quarter as continued strong growth in our fountain food service business was more than offset by declines in diet. Our Diet Dr Pepper business continues to significantly outperform the diet category declining at about half the rate of all diets driven by the strength of our Lil' Sweet campaign.

Our core four brands also declined 1% as over 5% growth in Canada Dry was more than offset by declines by 7UP, A&W, and Sunkist soda. Crush and Schweppes grew 4% and 9% respectively on increased activation at a large retailer. Squirt grew 8% on strong growth on both Mexico and the US and Penafiel grew 4%. All other CSD brands decreased 2% in the quarter.

In non-carbs, Snapple declined 2% as growth from product innovation was more than offset by the effect a year ago of liquidating certain Snapple inventories. As a reminder, Snapple growth in the second quarter last year was 11%. Hawaiian Punch decreased 5% as expected, driven primarily by price increases on single-serve packages. Motts was flat in the quarter as growth in sauce was fully offset by decreases in juice driven by price increases on single serve packages. Clamato grew 14% in the quarter reflecting continued strong growth across Mexico, the US and Canada.

Our water category grew 25% on growth on our allied brand portfolio, particularly Bai and Fiji and continued growth in Aguafiel. All other non carb brands decreased 10% in the quarter almost entirely due to our exit of the Country Time business.

Building our brands continue to be a critical element of our overall strategy and success and we've got another strong calendar of programming that is targeted against our consumer insights for the back half of the year. Our regular Dr Pepper 20-ounce program highlights 150 unique labels that allow consumers to choose their favorite bottle that represents their individuality. Though it's early on, we're seeing recent upward trends in our convenient and gas business and our consumers are showcasing their love for the bottles on social platforms such as Instagram and Twitter. You can also even purchase your preferred bottle on eBay.

As I mentioned earlier, our diet Lil' Sweet campaign continues to drive impressive results for the brand and will start college football off strong with heavy media across TV and digital platforms and activation in large national accounts. And new this year, Larry Culpepper will be tailgating across the country to bring Dr Pepper to every football gathering in his own Dr Pepper van.

Our Dr Pepper Cherry push is bringing new users in to the franchise and consumers are enjoying A&W root beer floats at their summer parties. Core four is bringing back monster-themed mini cans for Halloween with an app that will bring the monsters to life on their smart device. Canada Dry will continue to capitalize in growth in the [L] category with increased media through the rest of the year and will activate against Schweppes sparkling waters honing in on the growing mixer occasion. Snapple will remind consumers to make time for Snapple with quirky new real facts ads and will once again bring news to the [TO] with red, blue election-themed LTOs. Clamato has partnered with authentic Mexican beer to spice up outdoor gatherings as the original michelada. You may have seen our Mott's Secret Life Of Pets packaging in market and just in time for back to school, Motts will support schools with bonus box tops for education.

As you can see, we've got a tremendous amount of activity lined up that engages our consumers and gives our customers and partners programs to rally behind. Let me turn the call over to Marty to walk you through our financial results and our 2016 guidance.

Thanks, Larry. Let me start with the high level financial summary of the quarter, which as Larry just said reflected solid performance. Sales volume increased 1% with reported net sales up 2%. Core operating income was up 6%. And core operating margin was 22.8%, up 70 basis points. Core EPS was up 11% in the quarter. On a currency neutral basis, net sales were up 4%. Core operating income was up 8% and core EPS was up 12%.

Now let me provide some further details. Reported net sales increased 2% on about 2.5 points of favorable product and package mix, just over 1 percentage point of price realization and a 1% increase in sales volumes. Reducing this net sales growth was just over a point and a half of foreign currency translation and almost 1 point of unfavorable segment mix as concentrate sales were relatively higher this year.

Reported gross margins increased 120 basis points in the quarter, increasing from 59.3% last year to 60.5% this year of which 90 basis points was driven by the favorable effect of unrealized mark to market commodity changes. Lower commodity costs, primarily PET and aluminum, increased gross margins by 60 basis points and continued productivity benefits including those from RCI as well as certain other packaging and ingredient cost reductions, increased gross margins by another 50 basis points.

The impact of positive net pricing also increased gross margins by 50 basis points. Effect of mix, mostly from products purchased from others, reduced gross margins by 100 basis points. And finally, foreign currency reduced gross margins in the quarter by 30 basis points as Mexico sources certainly inputs in US dollars and finished products sold in Canada are sourced from the US.

For the quarter, SG&A, excluding depreciation, increased by $4 million on inflationary and certain other increases in operating expenses, including a one-time $4 million cost associated with a transition of a certain employee benefit program. These increases were partially offset by favorable foreign currency translation, a reduction in transportation costs driven by lower fuel prices, and $7 million of lower marketing investments year-over-year due to timing shifts of brand campaigns. Depreciation and amortization declined $2 million in the quarter.

Below the operating line, net interest expense increased $5 million, primarily reflecting an overall higher debt balance, and higher rates from our fourth quarter 2015 refinancing. Other income increased by $23 million in the quarter as a result of a $21 million gain on the extinguishment of a multi-employer pension plan withdraw liability. This gain has been excluded from our core results. Our reported effective tax rate was 35.3% compared to 35.5% last year.

Moving on to cash flow, cash from operating activities was $407 million, net of the $35 million payment of the multi-employer pension plan liability. Cash from operating activities was up $58 million compared to last year. Primarily driven by timing of certain working capital amounts and the increase in net income adjusted for non-cash items. Capital spending was $68 million compared to $42 million last year as we've spent incrementally to further support our growth in Mexico. Our new mineral water plant north of Mexico City should be operational in the fourth quarter of this year. For the first six months total distributions to our shareholders were $493 million with $303 million in shares repurchased and $190 million in dividends paid.

Before I move on to guidance, let me give a quick update on rapid continuous improvement. Our 2016 Lean tracks are in full swing. We've already had over 75 Kaizen events across the organization and we're seeing wins across the board. I'll share a few now.

In our Orlando DSD site, driver turnover has been reduced by 44%, driven by improved recruiting, onboarding, and performance management processes. Through this Lean track nationally we are also learning from our drivers other elements of waste that will enable us to further improve the effectiveness of our route delivery system. A job role safety play book developed by our front line employees is driving a 25% recordable injury reduction year-over-year in the second quarter, helping drive 12-month trend rates down almost double digits. We've closed over 2,000 voids on Dr Pepper smaller CSD packages in a large retailer through a similar process we use to close voids on other brands. And certain allied brands are experiencing both double and triple-digit growth rates partially as a result of our track specifically focused on allied brand distribution and availability.

And as I've mentioned before, we have a tremendous amount of RCI activity going on throughout the business in addition to our Lean tracks. Branch managers in our central business unit gained 10 hours per week of additional customer facing time by adopting the RCI principle of standard work and our Mexican team has improved Penafiel distribution with our third party distributors by creating standard work for trade management and point of sale.

We have great urgency to improve the performance of brand 7UP. Our Lean track is underway. While there's still a great deal of work to do, the team has diligently focused on the components of brand messaging and execution in local markets. Supporting this is a deep inspection of pricing, packaging, channel, and geographic competitive trends alongside those of 7UP. These insights should enable us to begin implementing certain changes in the balance of 2016. There's definitely more to come on 7UP. Again, these are just a very few examples of the vast improvement initiatives taking place across our entire business every day.

Now let me move on to 2016 guidance. We continue to expect reported net sales to be up approximately 2% inclusive of a foreign currency translation headwind of about 1%. Given our first half performance, we are increasing our full year core EPS guidance. We now expect core EPS to be in the $4.27 to $4.35 range. This is inclusive of what we now expect to be about a 3% headwind from both foreign currency translation and transaction combined, versus the 2.5% that we had expected previously.

We continue to expect total company sales volume to be about flat. Similar to our previous guidance, we expect CSDs to be about flat while we expect non-carbs to be up slightly. Remember that our non-carb volume performance is being tempered this year by pricing actions taken across several of our warehouse direct brands. However, we still expect continued growth from other non-carb brands such as Snapple, Clamato, and our allied brand portfolio.

On a total company basis we expect combined price and mix to be up about 3%. Our January 1 concentrate price increase will drive about 40 basis points of this increase, and price increases on our warehouse direct brands will drive an additional 20 basis points. The remainder will come from mix as a result of stronger growth from smaller CSD packages and brands such as Snapple, Clamato, and our allied brand portfolio.

Moving on to cost of goods. Given our hedge positions and current market prices for our unhedged positions, we now expect packaging and ingredients to be about 1% deflationary on a constant volume mix basis. This expectation still reflects deflation in commodities such as PET and aluminum. And as we've previously said, a headwind on corn, driven primarily by increases in tolling fees and unfavorable pricing of corn co-products from which we derive our net corn price.

For modeling purposes remember growth from some of our non-carb portfolio and allied brands will also increase the dollar value of cost of goods. And also remember that cost of goods is negatively impacted by foreign currency transaction, as I mentioned a moment ago. Collectively, all the factors I mentioned above should result in roughly similar gross margins in 2016.

Moving to SG&A, we now expect an increase of approximately $15 million in health and welfare and other insurance costs versus the original $20 million that we had previously expected. We also still expect general inflation on our field labor costs to increase operating expenses by approximately $20 million. That said, we believe we will be able to achieve productivity benefits from RCI that will help offset a portion of these increases and we're also now expecting favorability from lower fuel costs of about $10 million, more than half of which we have already experienced. We continue to expect marketing to be about 7.5% of sales for the year. This implies a significant uptick in the back half of the year, mostly in the third quarter.

Now, moving below segment operating profit, our net interest expense will be around 4.5% on our $2.9 billion of debt which implies a increase of approximately $15 million driven primarily by our fourth quarter 2015 debt refinancing. Our full year core tax rate is still expected to be approximately 35.5% and we continue to expect capital spending to be approximately 3% of net sales even with the spending for our new plant in Mexico. We also continue to expect to repurchase approximately $650 million to $700 million of our common stock in 2016, subject to market conditions.

Now let me highlight a couple of additional phasing items that will help you update your models. First, as previously mentioned, while we expect commodities to be deflationary for the full year, the deflation has already been experienced and our trends are expected to turn flat to slightly up for the balance of the year due to the year-over-year timing of a certain commodity related rebate. And second, based on timing of prior year true-ups, both the third quarter and fourth quarter will experience an increase in health and welfare and other insurance costs.

With that said, let me turn the call back over to Larry.

Thanks, Marty. Before we open the lines for questions, let me leave you with a few brief though consistent thoughts. Once again, we posted solid results in the quarter. We're continuing to focus on driving integrated communication, innovation, and execution across our key priority brands while also selectively adding to our allied brand portfolio to capture fast moving consumer trends.

We're continuing to embed RCI further in to our culture and we're seeing meaningful improvements in growth and productivity across the company. And importantly, we remain committed to returning excess free cash to our shareholders over time. Operator, we're ready for our first question.

Thank you.

(Operator Instructions)

Our first question comes from Ali Dibadj of Bernstein.

Hi, guys. Just a couple things and both on the packaged beverage business. I see they're a little bit less than consensus had it at. It's attributed to lower contract manufacturing volumes.

Can you help us quantify the impact of that? You mentioned in your comments Country Time, is it all Country Time?

Remember we heard back about this in 2010, 2011 I think it was roughly. At that point you're getting rid of or de-emphasizing some of your contract manufacturing. How much more of that is left? And I think that both from a volume impact perspective but also from a potential of improving your margins in that segment.

Ali, it's Marty. Good morning. So contract manufacturing volume is down a little bit in the quarter, probably an overall impact of maybe 1 point overall volume on packaged beverages. I'd say actually we're not -- as a matter of strategy in terms of helping us use excess capacity in our plants, it's still our strategy.

Business comes and goes in that arena. There are competitors there. And it's very geographic. We're only going to be effective dealing with retailers on their private label, for example, in the geographies where our plants are, and assuming those plants have the capacity to do their volume. Otherwise transportation makes it sort of a non-starter.

We're still going to aggressively pursue volumes in our plants where it makes sense to do so. At the same time we still do some copacking around the energy category and that business continues.

So this is not as it was in 2010, 2011, where we were getting rid of less profitable businesses. This is just the tide sometimes of business in that sector. That's what it sounds like.

Correct.

Okay. Within that context from an allied brands perspective, is it still driving more than half of your volume in revenue this quarter? I think that's what you said, or the past couple quarters. Just wanted to touch base with that. And would you ever put that into your contract manufacturing or is that just not part of the cards technologically or just to your point a moment ago given where you need the volume to be and given where the retailers are where your capacity is?

As we bring on these allied brands, when we first bring them in, a lot of them have agreements already with some people on the contract pack. As it's available and makes sense, we always look at it. We have great relationships with all our allied brands and we always look at it together and say if it makes sense for us to do it, we'll look at it. If not, we're fine with the arrangements we have right now.

Let me give some color. Across all of our allied brands, the entire portfolio, this quarter I will tell you they collectively were less than 2% of our volume, and less than 4% of our SOP in total for all of them. If you're curious as to like case growth rates, it was probably a half a million total cases of growth in there. Half a million to a million cases of total growth in there year-over-year in the second quarter.

Okay. Just to follow up on one of those. You mentioned we have good relationships with them, Larry. There's all discussion about some of the protection we have now that we own pieces of these companies. There's stuff in the press out there about how much you own.

Can you give us a little bit more detail about how much of the companies you own? Doesn't sound like a majority by any stretch of the imagination, press suggests a low single digit type ownership. Can you give us anything of how to think about the protection you actually have in the ownership stakes? Thanks.

The percentages we own are small, but we also have contracts in there that we have buyouts and certain things like that. We don't ever disclose all of them put together. We continue to feel protected on those.

I think the biggest thing that protects us is the performance we do for them. You look at the kind of growth we're getting there and the relationships we have, I don't think we lose too much sleep. It could happen. But if it does we'll recover. It's happened in the past and we've always recovered. We bring something else in, that's why we constantly look at them.

Looking at numbers, the growth product, probably worth half a point of growth this quarter. I may have understated the number a little bit. Let me follow on Larry's point.

We've talked openly about the strategy, and at some point given all these companies are run by entrepreneurs, the successful ones will look to monetize at some point. That's not a secret. As I've said before, we have a long pipeline of opportunities. In fact, I'll be headed to a meeting right after this call to do a review of that again.

And of course monetarily we have small pieces of equity and bioagreements and our distribution agreements which is worth a reasonable sum of money, shouldn't lose to distribution. I don't want anybody on this call to think that because one or more of these may change hands, that we necessarily lose the distribution either. There aren't too many other companies, there are a couple, but not many more that have the platform that we have in terms of our coverage and our relationships and our ability to work with the other large bottlers that today are a part of our network. As Larry said we bring a lot of value to them and we think there's a lot of future opportunity given some of the brands that we're now seeing presenting themselves to us to do similar kinds of distribution activities with.

Okay. Thanks very much for the dialogue there.

Our next question comes from Steve Powers of UBS.

Great. Thanks, guys. A couple of quick ones if I could, first on fountain, and second on 7UP. The fountain business is running a good bit ahead year-to-date of your historical growth. I'm curious as to whether we should expect that to continue in the second half or should we expect a correction or normalization on the back half.

On 7UP, as you called out the RCI initiative to improve that, is that something we should expect to see some movement on in the second half? Or is that 2017?

Good morning. It's Marty. Let me talk on 7UP. We're doing a lot of work as I said. We're finding some insights.

My comment earlier about the phasing of marketing 7UP is part of that because through our strategy work and consumer insight work we're changing the message on the brand and that's going to roll out in the second half. And you'll see probably some activation. You may not see it but the market will see some changes in activation at retail.

There are some new and different thoughts that have arisen that we're going to try here in the second half of the year. It's a lot of work in progress. We're encouraged by it. Obviously it is the weak spot in the Core Four. Everything else is actually performing fairly well. So more to come on that. First half of the question was --

The fountain business.

Fountain, we've done reasonably well in fountain. We've had historical growth rates 1% to 2% for a while. We continue to gain valves. Our team is doing a good job.

We're increasingly selling in the regional strength of our brands as all of you know in regions of the country. That's an advantage for us. And the freestyle business that we have with Coke has seemed to improved so we're selling more syrup into cartridges going into freestyle machines. That's of course good for Dr Pepper.

Okay. Stepping back, in May we had the FDA announce new packaged food and beverage labeler requirements with more focus on both calorie disclosures as well as importantly the added sugar disclosures. Given your portfolio skewing towards full calorie CSDs and full sugar beverages generally, I'm just curious how you're approaching that change and do you have any clarity on the timeline to implement it? And then, any guesses on the impacts to your business, any mitigation efforts just doing, whether it be more accelerated portfolio shifts or more accelerated investments in smaller pack sizes, that kind of thing. How are you thinking about the pending changes?

Well, on the changes, we will follow the guidelines and as far as the sweetened beverages, we've been seeing growth come back into the sugared beverages. I don't see us changing anything there.

I think I was glad to see it's going to be more of a federal labeling instead of having 20 different ones out there to where it really drives the cost up of packaging and distribution. So we were happy with that. And we think the ABA and our guys all did a great job there on helping get that through. But I don't see any significant impacts that I'm too concerned about.

Does it roll in to the market in the second half or is that 2017?

I think it's going to be later than 2017.

Okay. Fair enough. Thanks.

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

Thank you. Good morning.

Good morning, Judy.

First on Snapple, just wanted to get a little bit more color just in terms of how much that the inventory issue impact volume in the quarter, then maybe taking a step back, Snapple obviously has been a pretty good growth driver for you guys and tea category seems to be growing. But the consumers seem to be trading up to more of a premium tea and Snapple seems to be lagging the category growth a little bit. Just wanted to better understand what the strategy to accelerate Snapple's growth going forward.

As I said in my remarks, we've got a lot of good new advertising we're doing with Snapple. We've got more LTOs laid out. The quarter, like I said, was up 11% a year ago, and then we had inventories we had to move because we've been telling people all along we started de-emphasizing the value.

There was a lot of factors for the second quarter that made the difference on that. I think you'll see going forward with the programs we have in place that Snapple will get more of a clear message out there of what Snapple is and where we play and with what the consumer wants.

I don't know if everybody is really trading up to a premium. It's kind of -- you've got flavored teas out there and you've got regular teas. I think that's the big place where you're seeing the shifts.

We see a lot of the tea drinkers. We have straight up tea. But they don't take anything away from the Snapple drinker.

That flavored drinker on Snapple and flavored teas, they like that flavor, they're going to stay there. We continue with our strategy on our flavored teas and our Snapple juices. Then we continue putting distribution out there on our Straight Up Tea.

Okay. Then Larry, in just kind of looking at the broader CSD kind of shelf space, obviously with the category I think is seeing a bit of a decline in terms of shelf space kind of broadly over the past few years. You obviously have many brands in the portfolio and some brands like 7UP that's declining in terms of volume. Just wanted to understand how you protect that shelf space. When you think about maybe Monster launching Mutant in the CSD space and what that implication could be in terms of -- particularly in the C stores as you think about protecting your own shelf space there.

One, we're not losing any shelf space. And I think what really helps us there, Judy, when you look at we're number one ginger ale, number one root beer, if we're not number one, number two, we don't even have it on the shelves out there. We do very good on our accounts for the category management for the account, but our brands carry the weight there for us. We're fine there.

I think on -- you brought up the monster. Not just monster but a lot of these brands come in, they try to get in different places, and they've not been very successful at it. There's been ones that will want to get in to the coffee, want to get in to the dairy, they want to get in the juice aisle, they want to get in the CSD aisle.

Most of your retailers, most of our customers want them in a block. They keep them in the same area. We'll have to watch it. We're not that concerned with it. We think we'll see if it happens over there, probably be more along the lines of private label which is continuing to decline, maybe losing some space.

Got it. Okay. Thank you.

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

Good morning. Larry, just wanted to talk about North American CSD pricing, we've seen at least (inaudible) channel start to lose some stream there. Are you seeing anything different, specifically talking about some of the markets where Coke has refranchised recently. Are you seeing any pricing activity there or change in how pricing has been in those markets?

We're seeing pricing as flat. I think before we might have seen a little shift in mix and different things with packages but pricing is flat. That's not a bad thing. I think there's still a tremendous amount of discipline out there and we don't see any reason that would change.

And no change in recently your franchise markets?

No.

Then a question on the modular trajectory of the packaged beverage business. You talk about single serve, even the premiumization of some categories. Is this kind of trajectory a margin improvement and understand that allied brands probably weigh it down a little bit. Is this the right trajectory or should we expect a little bit stronger as we go along on this path?

Good morning. First of all we're very pleased with the trajectory of packaged beverages operating margins up again this year about 100 basis points year-over-year. And you're right, on an overall segment basis, the allied brands actually weigh it down a little, but they're still very profitable way down average margin.

I'll also remind you why said in our prepared remarks and press release, packaged beverages took a $4 million nonrecurring hit quite frankly. We took the fuel people out of their company cars. We made a one-time payment to do that. We expense that in the quarter.

Also, I'll be honest with you. Some of the operating costs are up more than we would expect on a long-term basis because we're making some investments in our front line. Lots of activities going on. It's no secret.

Everybody is sort of worried about their front line people. And we're taking care of our front line people and we're spending a little more money to do that. All of you know me. The runway for RCI improvement is as far as I'm concerned unlimited. We find more opportunity every single day in this business. Therefore we're pretty confident that actually packaged beverage margins can still appreciate at some level.

The last question and a follow up to Judy's question on shelf space on CSD. So understanding that you're not losing any shelf space but are you seeing the overall CSD category shelf space maybe being given to some of the other categories?

We've not seen anything significant, no.

Got it. Thank you very much.

Our next question comes from Vivien Azer of Cowen.

Hi, Good Morning.

Good Morning.

I wanted to follow up please on the commentary around 7UP and the evaluation that you are doing. And you called out pricing is one lever that you would be inspecting. And I'm curious if you could expand on that a little bit, just given how narrow price gaps are in the category more broadly. Thank you.

What my comment was, it's everything. It's pricing, it's packaging, it's channel, nothing specific per se that we're going to call in terms of pricing in a market in a package. But we're looking at over on how the brand performs, the elasticity, the historic date on elasticity as to what we think about current elasticities, as we think about all the time balancing price, share with regard to, for example, protecting our space, but big time profitability. So, there's nothing there, there's no -- let me allay any fears. There's no strategy here to sort of lower price on 7UP as a way to grow the brand. That's the last thing that we're going to do.

Yes, that's not sustainable, and you just rent volume when you do it with price.

Okay, that seems reasonable enough. Thank you for that.

My next question has to do with diets. It's certainly encouraging that you guys are outperforming the industry. But given how many years we are in to this outsized decline in diets, I was wondering if you had any updated thoughts on that, just given that we continue to see the volume base shrink.

Is there a mix in terms of where that volume bleed is coming from? Do we continue to lose consumers? I'm sure it's a balance between losing consumers and reductions in per capita consumption. Has that balance shifted at all over the last few years as the declines persist? Thank you.

Like I said, we're outperforming the category, but I don't think we're losing consumers. If you look at our broad portfolio, especially with our allied brands, we have some people going over to some of our allied brands, some of our better for you, some of the diet brands in there. I think we'll continue our Lil' Sweet campaign. We're seeing it get momentum.

So I think we will find the bottom of where it's at with Dr Pepper. I think if you look -- if you break the diet category down, there's categories losing much more of the volume. I think we're going to get it. But I still think some of our consumers as we continue our insights, we're not losing them. Their switchers are going to other brands and we're keeping them in our portfolio.

That's helpful. But within diets for those consumers that are just kind of leaving, are you also seeing reductions in per capita consumption or is this really more of a migration to other pieces of your portfolio?

We're not really seeing it. Household is holding up. Household penetration. The per caps are still there I think. You've just got some concerns about the sweeteners that are going to something else.

Okay. Thank you so much.

Your diet drinkers are some of the most loyal consumers you'll ever see on their diet brands.

Understood. Thank you again.

Our next question comes from Bill Schmitz of Deutsche Bank.

Hey, guys. Good morning.

Good morning, Bill.

Did you have any impact from the fountain shift you talked about last quarter? I thought there was like a full forward of fountain. It wasn't mentioned in the call or press release.

Actually last quarter I reminded everybody we actually had an acceleration of an order that helped our fountain business, we thought that would turn around. The fountain business stayed healthy all throughout the quarter. Specific freestyle orders remained healthy as well.

Okay. You said advertising on market is going to be 7.5% of sales for the year. Can you tell us where you are year-to-date?

Probably around 7%. We're probably right around 7%.

Okay. Then you said there's going to be a big uptick in the third quarter relative to the other quarters, is that right?

Right.

Okay. Then lastly, is there any way to sort of disaggregate your growth between same-store sales and distribution gains? I know when I was out there you talked a lot about having this RCI track on distribution voids? Is that getting decent traction, are there any big opportunities to actually move the needle?

We talked even last year, we've closed voids through RCI lean tracks on Snapple, on Canada Dry, I mentioned a specific activity around Dr Pepper. We look at velocity, points of distribution and velocity all the time internally but there's no way I can share with you for modeling purposes how you can model growth, for example, between new points of distribution and velocity from existing points of distribution.

Okay. That's fine. I just thought I'd take a stab at it. Thanks very much.

Our next question comes from one of Caroline Levy of CLSA.

Good morning. Thank you. Couple of questions from me. Your debt EBITDA coverage is very good. So I just have to ask if you guys would consider either stepping up your repurchases or if you see a brand out there that might be attractive to own versus users in allied brand? How do you think about that?

Caroline, good morning. It's Marty. Our debt level roughly $2.9 billion is where we have targeted to be, not that we wouldn't raise it for something that necessitated us to do that. It would not be for share repurchases. We're buying our shares out of our free cash flow which as I said in my remarks pretty healthy and had a pretty healthy increase over prior year.

I don't know. That's pretty much it. We've stayed at this level for a little bit. We did raise a little more money at the end of the day last year. I referenced that. We took advantage of the yield curve at the time and did an incremental $250 million at 30-year, about 4.5%.

That's going into share repurchase this year if you look at our $650 million to $700 million, it's roughly $250 million higher than our $400 million to $450 million average per year amount. That's simply reflecting that incremental $250 million bond, but there's no other plans to significantly change our capital structure.

Great. And what makes you decide that you would actually acquire a brand outright versus taking the allied strategy?

Well, it's never say never, but our history has been to be very prudent about how we use our capital. And when you say buying brands, that's sort of a generic question. Brands come to us all the time early stage. They're not selling. And actually at early stage if they were, they would want such a -- in our view, a large sum of money as to make it just a non-starter for us.

We're just not going to -- we're just not going to get involved in those sorts of risky investments. We just don't feel we need to do it to come back to a TSR algorithm for this company that really only requires us to grow the top line 2%, maybe 3% to get close to a double digit expected return with our free cash flow yield. We're not really trying to step out of that model.

Got it. That makes a lot of sense. Just want to ask you on RCI, forgive me if you've already talked about this. When you look at advertising and promotion, are you seeing opportunities through the shift to digital to really reduce spending and get the same impact?

Yes. Digital, in our marketing return on investment work, digital shows some of the highest returns and if your question goes to sort of the dollar cost-effectiveness of digital, for example, than traditional TV, yes, you can. But your digital too is getting pricey as well because everybody is trying to take advantage of it.

There are a lot of things we're doing in marketing that comes specifically from our marketing return on investment work which is yielding improved effectiveness on that same level of marketing spending, that 7.5% of sales. One of the reasons we don't feel we need to do more is because we're getting good results moving our TV spots from 30 seconds to 15 seconds, depending upon the campaign, all sorts of shifts around between I'll call them prime channels and cable channels. Programmatic through digital display.

There's lots of things we're doing and learning from ROI, reducing in certain markets traditional out of home billboards, local radio. There are places where they're effective but we've discovered lots of places where they're not and we've spent a lot of time working with our marketing folks to analyze this data and shift our monies where we get the best return.

It's very consistent with RCI. That's an area, we want to find the waste and we want to redeploy it. And slowly but surely we think we're getting there.

Thank you. That's great. My last question is for Larry if I could, just given your perspective on the industry. Do you think that for carbonated soft drinks, some of the weakness in the total category has more to do with colas than anything else? Do you think it's very specific to cola? Because Dr Pepper does seem to be outperforming.

I think Dr Pepper and the flavors both are outperforming. You look at the change in our demographics also, it's switching less more to people who are wanting the flavored CSDs, the full sugars. The colas have had decline for quite some time. And I think it's more of a cola than what we're seeing in the flavors. The flavors continue to be strong and that's why we look at them positive and say that we think we can keep CSDs basically flat to maybe up a little bit.

Got it. Thank you so much.

Our next question comes from Bonnie Herzog of Wells Fargo.

Hi, Bonnie.

(Operator instructions)

Our next question will go to Kevin Grundy of Jefferies.

Thanks. Good morning guys.

Good morning Kevin.

Larry, question for you, back to the diet category. Pepsi recently announced that they are returning to the original formula. What, if any, impact do you expect to see on your portfolio?

None. I think they're going to have a little bit of all of them out there. I think we don't make changes -- we don't jeopardize anything on the taste or our consumers and customers that rely on us. They're very loyal. So I don't think it will have any impact.

Okay. Thanks. Then Marty, one for you. Return of capital. We're seeing dividend payout ratios edge up here in the consumer staple space which is unsurprising given where interest rates are globally.

Can you touch a little bit on that? Any update understanding it's a Board decision? Any change in philosophy there potentially with respect to your dividend payout ratio?

So Kevin, it is a Board decision. It is a decision taken up typically at our February meeting every year. I said and I'll say again, if we -- and I believe our Board, can't speak for them, but I believe if we had to lean in one direction or another, it would be to increase the dividend over and above putting more money to share repurchases and that would be our tendency. I wouldn't look for a dramatic change but we'll take that up in February.

Okay. That's helpful. One quick housekeeping question, just because fountain food service seems to becoming more topical and a bigger contributor to top line growth. Is that still about 10% of volume mix for the company? Is that roughly accurate Marty?

That's correct.

Very good. Thank you, guys.

Your final question this morning comes from Brett Cooper of Consumer Edge Research.

Good morning, guys. Quick question on brand fragmentation. Specifically I think it's more common outside of CSDs. Your thoughts on that going forward. And then wanted to understand your capacity to take on new brands, how that evolves over time given some of the efforts that you're making in the DSB business with RCI.

Your question referred to non CSDs, and what-- Does it go to our ability to deal with an increased number of brands in our system?

Your capacity to take on allied brands. Is there a bottleneck in doing that? And yes, also the idea of sort of as skews proliferate, what does that do to your call space?

It's a great question because RCI is a real important element to make sure that the complexity that comes from [handling] these brands actually doesn't result in higher cost. Early on particularly when these brands are small, order size is small, pack sizes, case sizes, delivery size of these brands are smaller.

Through RCI we learn how to do this still at a very effective cost. That's been one of our efforts in our warehouses with RCI. Because we've always had to handle a lot of brands. We've always had a pretty broad portfolio of brands. This is something we've had to get good at. And the allied brands get us even more focused on it and we have plenty capacity.

Okay. Can you talk about -- historically where we've seen DSD operations struggle with small brands and opportunities coming at small brands. What is it you do differently than maybe some of your other competitors in terms of being able to nurture these brands as they go in to market in a relatively small scale versus what we're used to seeing?

Probably the biggest difference that you see with our packaged beverage and our DSD system is unlike our competitors, whether it's soft drinks or beer, we don't have one brand that is 50%-plus of the sales. Our guys, all their careers have managed a lot of brands and been able to manage them well, have them on display, have points of interruption, get the shelf space and sell more than just delivering just a bulk delivery out there.

So I think it just really works well whenever we get the new brands in, the allied brands, that they see that these guys can go out and sell. They're some of the best sales guys we've got around. They get the job done.

Perfect. Thanks.

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

Thank you for joining the Dr Pepper Snapple Group second quarter 2016 earnings conference call. Please disconnect your lines at this time and have a wonderful day.