Keurig Dr Pepper Inc (KDP) — Q3 2018 Earnings Call Transcript

Thank you. Hello everyone and thanks for joining us today for KDP’s first earnings call. I hope this slightly later start time is more convenient for you. This afternoon, we issued our press release for the third quarter of 2018, and we’ve previously filed an 8-K containing our historically adjusted pro forma quarterly results, both of which are available on our website. As you know, this past quarter was a busy one for KDP with a lot of progress made across the business. Here with me today to discuss our results of the quarter and our outlook for the year are KDP’s CEO, Bob Gamgort, and our CFO, Ozan Dokmecioglu. Before turning the call over to Bob, I would like to take a moment to provide some context on the adjusted pro forma basis upon which much of our discussion today of financial performance will be based. As you know, our results start with reported GAAP financials. Due to the merger and unique adjustments required to make year-over-year comparisons helpful, we prepared pro forma basis that takes these impacts into account. These adjustments include resetting the transaction date as if it were consummated on December 31, 2016, eliminating one-time merger-related costs and expenses, and normalizing any accounting differences between the two companies. With these differences accounted for, we then adjusted this pro forma for items affecting comparability not related to the merger, such as the typical mark-to-market impacts, restructuring expenses, and refinancing costs among others. The Company believes that the adjusted pro forma basis provides investors with additional insight into our business and operating performance trends. While the exclusion of these items is not in accordance with GAAP we believe that it is a meaningful comparison and an appropriate basis for discussion of our performance. Details of the excluded items are included in the reconciliation tables in our press release and are discussed in detail in our 10-Quarter, which will be filed shortly. Finally, our discussion this evening may include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially. And the Company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the Company's filings with the SEC. With that, I’ll hand it over to Bob.

Thanks, Maria, and thanks to everyone for dialing in. Before jumping into the results of the quarter, let me take a few moments to share my perspective on how the integration has progressed since we closed the merger in July. The integration management team established shortly after the merger was announced in January, successfully transitioned the two companies into one. We announced the new leadership team in June, implemented new decision and governance processes soon thereafter, and have cascaded our new combined structure throughout the organization. We continued the strong momentum of both legacy businesses and have had no disruptions in customer service or systems, an accomplishment that none of us, who are experienced in acquisition integrations, ever take for granted. Most importantly, the KDP organization is learning to work together. We are energized by the unique opportunity that KDP represents. That energy and excitement has translated into strong performance in Q3, both financial and in-market, and we look forward to closing 2018 on a strong note and entering 2019 with continued momentum. Turning to some highlights of the quarter, starting with in-market results, based on IRI. Retail market performance remained strong in the quarter. Our CSD portfolio registered market share gains in both units and dollars, driven by strong performance of Dr Pepper and Canada Dry. In addition, we grew our coffee portfolio in the quarter, driven by single-serve category unit growth of approximately 7%, combined with a substantial increase in unit and dollar market share of pods, manufactured by KDP. We also continue to gain share and enhance flavored still water, and we held share in both shelf-stable tea and juice and juice drinks. Turning now to the financials. On an adjusted pro forma basis, net sales were up a solid 2.9% with growth registered in all four business segments, driven by a 3.6% increase in overall volume and mix. Operating income advanced 14.3% or 240 basis points to 24.4% of net sales, primarily reflecting the growth in sales, continued strong productivity, and timing-related lower marketing expense, which collectively offset inflation and input costs and logistics. Adjusted diluted EPS advanced to $0.30 in the quarter compared to $0.21 in the prior year, with a significantly lower effective tax rate this year, benefiting the comparison, along with the cash distribution from BODYARMOR we received as unitholders. Turning to our segments. I’ll start with Beverage Concentrates, which posted solid results in the third quarter. Net sales, which represent our sales of concentrates to bottlers and serves to fountain customers, advanced 3%, driven by growth in both net pricing and volume mix. The increase in net sales was driven by strong growth of Dr Pepper, as well as increased sales for A&W and Crush, partially offset by Sunkist. Operating income for the Beverage Concentrates was even with last year, primarily reflecting the growth in net sales, offset by higher performance-based compensation and inflation in input costs and logistics. Turning to Packaged Beverages. Packaged Beverages delivered very strong topline growth with volume and mix up approximately 6%, partially offset by modestly lower net price realization. The decline in net pricing was driven by Bai and BODYARMOR, significantly offset by higher CSD net pricing we began to realize, as a result of pricing actions we initiated during the quarter. Driving the net sales momentum in the quarter was double-digit shipment volume growth in Canada Dry, reflecting successful innovation and continued growth of the ginger ale segment. Also contributing to the growth were Core Bai and BODYARMOR, partially offset by 7UP, A&W and a modest decline in Dr Pepper. Increases in contract manufacturing also had a significant positive impact on the quarterly growth. Operating income declined 16% in the quarter due to inflation of both input costs and logistics, which were not yet fully covered by our pricing actions. Also impacting the comparison was continued investment behind our front-line sales and merchandising workforce. Last month, we started the new season of our highly successful Dr Pepper college football marketing and advertising support. This year's campaign called Fansville has a storyline that evolves over the course of the season, culminating in the college football championship. In addition to TV, the campaign includes digital and social media, print advertising and in-store support, and will be complemented with this year's 10th anniversary of the Dr Pepper Tuition Giveaway, which has awarded over $10 million to college students and will be presented at the Conference Championship games. For the holidays, we will again launch our Holiday Green Bottle program behind Canada Dry, 7UP and Squirt. Thousands of supermarkets across the country will have the familiar holiday display punctuated by fun specific packaging. Additionally, this year the displays will be accentuated with Bai and its distinctive red caps. Full program is supported by digital and social media. Now, turning to Latin America Beverages. Latin America Beverages posted a strong third quarter with net sales advancing 2% and operating income more than doubling. The net sales performance reflected higher net pricing of 9%, partially offset by unfavorable foreign currency translation of 6% and lower volume mix of less than 1%. Peñafiel and Mott's were the primary drivers of net sales growth in the quarter. Operating income for Latin America Beverages more than doubled to $27 million in the third quarter, primarily reflecting the growth in net sales and the favorable impact of comparison to the year-ago write-off of prepaid resin inventory. These factors were offset by inflation in both input costs and logistics. Now, turning to the Coffee Systems segment. Coffee Systems reported a very strong quarter, with modest net sales growth driven by volume mix growth of 2.5%, partially offset by lower net pricing, which continued to moderate significantly on a sequential quarterly basis. Modest unfavorable foreign currency translation also impacted performance. The net sales growth was fueled by volume growth of approximately 3% for pods and 8% for brewers as well as higher brewer pricing due to innovation, partially offset by the aforementioned strategic pod pricing investment. We launched our new coffeehouse brewers, namely the K-Café and the K-Latte that enable consumers to make lattes and cappuccinos at home using any K-Cup pod. In addition, we launched our updated K-Mini brewer platform with new features and a modern sleek design. Each of these innovations is a reflection of our robust consumer-centric innovation program designed to drive new household penetration of the Keurig system by addressing barriers to adoption. Importantly, each is performing well in the market with very strong consumer reviews. We will drive consumer demand for our brewer innovation with a strong investment behind the second year of our Brew the Love campaign, featuring a talented and energetic James Corden as our brand ambassador. The campaign running this quarter highlights the K-Café brewer and its ability to make every house a coffeehouse. Operating income for Coffee Systems was up a very strong 26% in the quarter, reflecting the net sales performance, strong productivity and lower marketing due to timing, despite inflation in input costs and logistics. Before I turn the call over to Ozan, I’d like to talk about how partnerships remain an important part of our strategy. Since the closing of the merger, we acquired Big Red and agreed to acquire CORE Hydration, bringing these two partner brands into our owned portfolio. We also added Forto Coffee Shots as a new partner and expanded our distribution relationship with Peet's for ready to drink iced espresso. In addition, just last week, we entered into a long-term partnership to sell, distribute and merchandise the iconic evian brand across the U.S. As part of the allied brand reset Fiji and BODYARMOR exited the portfolio. Partnerships are at the core of the Coffee Systems portfolio, and we added Tim Horton’s, the iconic coffee brand in Canada and Panera, the well-regarded bakery-café brand in the U.S. as new Keurig system partners. We now have more than 75 owned, licensed and partner brands in the Keurig system. As you can see by these actions, we have significantly reshaped our allied portfolio in short order with a focus on creating long-term win-win partnerships that enable both parties to benefit equitably in future value. We’re excited about continuing to drive growth through a combination of partnerships with other leading beverage brands and by innovating and renovating our portfolio of owned brands. With that, I’ll hand it over to Ozan.

Thanks, Bob, and good evening, everyone. Let me start with the results of the quarter, which was a very good one for KDP, and then transition to our outlook for the remainder of the year. Continuing on an adjusted pro forma basis. Net sales for the third quarter increased 2.9% to $2.86 billion compared to $2.78 billion in the previous year, reflecting strong growth across all four of our business segments. Driving the net sales growth was higher volume mix of 3.6%, partially offset by unfavorable foreign currency translation of 0.5% and modestly lower net price realization of 0.2%. Net sales for our Beverage Concentrates segment increased 3.1% to $331 million, driven by higher net price realization of 2.7% and increased volume mix of 0.7%. Partially offsetting these positive factors was unfavorable currency translation of 0.3%. Shipment volume growth for Beverage Concentrates of 0.5% was driven by Canada Dry, reflecting innovation and continued strength of the ginger ale segment. Also contributing to the volume growth were Crush and Hawaiian Punch, partially offset by Sunkist and a modest decline for Dr Pepper. In terms of bottler case sales, which primarily reflect sales from bottlers to retailers and fountain customers, Beverage Concentrates reduced their growth of approximately 1% in the third quarter fueled by higher growth of fountain case sales. Net sales for our Packaged Beverages segment increased strong 4.9% in the quarter to $1.34 billion as compared to $1.27 billion in the prior year. This was fueled by volume mix growth of 5.7%, partially offset lower net price realization of 0.7% and unfavorable foreign currency translation of 0.1%. As Bob mentioned, the lower net pricing was largely due to Bai and BODYARMOR with the pricing actions we initiated on our CSD portfolio during the quarter, serving as a significant offset. Shipment volume grew 4.5% in the quarter. Canada Dry led our portfolio with double-digit growth fueled by innovation and continued growth in the ginger ale category. Also driving the strong growth were Core Bai and BODYARMOR, partially offset by 7UP and the modest decline in Dr Pepper. Increased contract manufacturing volume also had a significant positive impact on the growth in the quarter. Net sales for Latin America Beverages increased 2.3% to $136 million compared to $133 million in the prior year. This performance was driven year higher net price realization of 8.7%, partially offset by unfavorable foreign currency translation of 5.8% and lower volume mix of 0.6%. Finally, net sales of our Coffee Systems segment grew 0.4% to $1.05 billion in the quarter. This growth was led by higher volume mix of 2.5%, partially offset by lower net price realization of 1.7%, which continued to moderate significantly, as expected. Unfavorable foreign currency translation of 0.4% also impacted the performance. Turning to operating income. In the quarter, operating income increased 14.3%, to $697 million compared to $610 million in the prior year. This performance was driven by the net sales growth, strong productivity and lower marketing expense due to timing, partially offset by inflation in input costs and logistics. On a margin basis, operating income advanced 240 basis points to 24.4% in the quarter. The strong operating income growth of 14.3% in the third quarter reflected significant improvement from the slightly negative operating income performance through the first six months of the year, bringing our performance for three months to a positive 4.4%. Interest expense totaled $167 million in the third quarter of 2018. I would like to spend a few minutes on interest expense as this is an important metric. On a year-to-date adjusted pro forma basis, interest expense totaled $517 million. This amount includes six months of interest expense calculated on a pro forma basis, meaning it assumes a full merger debt load, starting on January 1st and reflects only mandatory repayments required under our credit agreement. Clearly, these assumptions are in accordance with U.S. GAAP and related treatment for the preparation of our pro forma financial statements. However, in the first 84 days since merger close, we already repaid $550 million in debt, and our original full-year interest expense remains at approximately $600 million in year one. Net income increased 39% to $414 million in the quarter, driven by operating income growth and significantly lower effective tax rate due to U.S. tax reform combined with a gain resulting from the cash distribution from BODYARMOR we received as unitholders. Taking all of these factors together, our adjusted pro forma diluted EPS increased 43% to $0.30 per diluted share compared to $0.21 per diluted share in the prior year. As Bob mentioned previously, we got off to a very strong start in the quarter with our $550 million of debt repayment, an area of significant improvement. This performance will enabled by our strong operating profit results and effective working capital management, both of which we expect to continue. In fact, the debt repayment in the quarter is consistent with the deleveraging outlook and value creation framework we shared at the time of the merger. And finally, in terms of our outlook for the year. For the full year, we continue to expect adjusted pro forma diluted EPS in the range of $1.02 to $1.07 per share, after the impact of preliminary purchase price accounting adjustments which are estimated at $0.04 per diluted share. For the first nine months of 2018, adjusted diluted EPS totaled $0.74. We continue to expect merger synergies totaling $600 million over the 2019 to 2021 period with $200 million in savings expected each year as well as ongoing productivity across the business. Our effective tax rate for 2018 is estimated in the range of 26% to 26.5% for the year. For the fourth quarter, we expect our EPS to approximate 26%. In addition, we remain committed to driving significant cash flow generation to enable rapid deleveraging with a targeted leverage ratio of below 3 times in two to three years from the time of the merger closing.

Thanks, Ozan. To summarize, the third quarter represented a strong start for KDP. In a very short period of time, we made progress across the business from organization structure to integration planning to delivering a strong first quarter as a combined company. During this time, we also reshaped and strengthened our partnerships across both our hot and cold businesses, and set the stage for a strong finish to 2018. We’ll now open the lines for your questions.

I was wondering if you could share more about evian and its role in your portfolio. It seems to me that there is some untapped brand strength that isn't fully reflected in its distribution. Could you discuss the specific opportunities for that brand and why it aligns with your strategy to target the value-add or premium water segment? Thank you.

Water category in total, as you know, is very much on trend and growing. You can look at water and segment it, depending on how you look at it, into somewhere between 6 and 8 different sub-segments of water, premium sourced Stillwater is a very attractive segment, both in terms of its size and growth. Evian was the original premium bottled water. It really does show though that the power of the brand met the demand with the power of distribution. So when they lost their previous distribution agreement, they were actually the largest premium sourced water brand at that time. And the brand that the legacy DPS business with Keurig PG was much smaller and you could see there's a complete reversal in trends at that point in time. So we are really excited to be able to bring full distribution back to evian. Danone is a terrific partner. They love this brand. This is the largest premium water brand in the world. It is a flagship brand in their portfolio and they're very excited to invest in marketing and innovation now that they have confidence that the distribution and merchandising base will be back up to where it needs to be for a brand of this stature. So it's a perfect complement to our portfolio. It's a gap that we wanted to fill and we are excited about the growth prospects of getting it back up to where it once was as the leading premium water brand in the country.

And if there is a room for second question, I know Bob you've reminded everybody that Allied Brands are only 5% of total company sales and profit. But I just saw it in the form it might be helpful if you could recap how you are updating the portfolio, but more how you put yourself in a better position to capture value you are creating for your partners, instead of avoiding hits down the road.

So I think it's just a recap on where we are only a few short months into the combined business on the Allied portfolio; we have added evian, Peet's Iced Espresso and Forto Coffee Shots, which are shipping now; we acquired Big Red and Core, we are excited about those; Fiji and BodyArmor exited the portfolio. And then we continued on with no change in distribution agreements for Vita Coco, High Brew and Neuro. And so really the Allied portfolio has settled out nicely in a fairly short period of time. As we said with all the pluses and minuses of that, there is no change on our earnings or EPS when you net those all out. I think when you think about 2019, which we'll talk about, there may be some slight headwinds to a one-time reset in growth because you're taking some big businesses out like BODYARMOR that actually weren’t growing very much. And you are replacing them with some smaller but faster growing businesses. So that's really just a one-time adjustment, has zero impact on our profitability at all. And we think we’re in a really good starting point, but we want to do more. And the go-forward position on Allied brands is we're targeting that field gap in our portfolio, because we want to make sure that it's an incremental volume generator by its nature.

Just two quick ones for me. I guess one just a clarification on in terms of the $600 million of interest expense in year one that's I guess second half of '18 through the first half of '19, right?

Right.

My second question for you, Bob, is regarding the margin expansion in coffee systems that we saw this quarter. There's been significant attention on the price reductions in pods, and some people are concerned about whether margins can continue to grow with these price cuts. Could you explain your current position on this issue and the factors contributing to margin expansion in coffee systems as we look ahead?

Let me talk about the growth side first and where we stand on that, and then I'll talk a little bit about the margin side. We were very happy with the performance that we put in coffee systems during the quarter. And it very much represents the execution of the strategy that we talked to you guys about for a while now. If you take a look at the pod category, and this is IRI but it's a good proxy for even what we see in some of the unmeasured channels. Pod category grew 7%. We grew share of pods manufactured by KDP. And therefore, our consumption in the quarter on pods was 9%. Now, there's a little discrepancy when you take a look at the shipments. During the quarter, you see plus 3% for pods, that’s really simple. It's just a year ago comparison to a shipment timing where a year ago, we were implementing SAP and so there were advanced shipments in the third quarter that were bumping up again. But the fact that there was 9% growth of consumption during the quarter really speaks to the robust growth that we're seeing in the total system. As you know from a pricing standpoint, we've been very strategic is taking price down. We've done that for a couple reasons. We've done it to address the number one consumer barrier to entry two years ago, that's now largely gone away, which was pod pricing. And we also want to compete on a different level and attract the right partners into the system based on price and quality and service. And we talked about we attracted Tim Horton’s to come into the system, which is the leading coffee brand in Canada. That’s further evidence of that. We clearly have been able to offset those pricing concessions by very robust productivity, and that productivity is really across the entire supply chain of the business on the procurement side on our conversion and logistics. And we also have productivity that we've been able to generate on the brewer side of the business. And so there is a lot of moving parts in that, but I think the proof is in fact that we're able to reduce price and yet still significantly expand margin, a lot of hard work behind that. But it's delivery of the productivity. And then last point to make sure I covered everything you wanted. Last one is really pricing. When you take a look at average pod cost price in that category, if I look at them on a 52-week basis, it was $0.51. If I look at it on a 12-week basis or four-week basis, it was $0.50. So we said $0.50 is about the right price point in the category, it's not exactly it's about that based on other research that we've done. And you see the moderation there going from about $0.51 to $0.50. And if you look at it for our business, because we have more premium brands on the manufactured, KDP manufactured, we're going from $0.54 to $0.53. That's the moderation that we're really pleased to see. And if you compare that to history, you will see that that's a significant change in slope. So very much on track with the strategy that we talked to you guys about over the past six months, and absolutely thrilled with the performance in the quarter.

So I guess first question is just on the DPS side, the packaged beverage division. I know that the margins there have been under pressure, just given a lot of the input cost inflation that a lot of the industry players are facing, obviously. But it seems like pricing went through and maybe that a little bit of delayed pricing. But I guess I am just wondering how much of some of these input costs inflation you’re expecting to recoup in the fourth quarter and 2019? And then there’s been a little bit of maybe choppiness around how some of the leading CSD players were taking pricing in the marketplace, some with a little bit of a delay. So how do you think about the competitive dynamics as you’re taking more pricing in that category?

So if you go back to the release that we did for the second calendar quarter of the year, we put results out for DPS and KGM especially separately, because we weren’t running the business at that point in time. But we did allude to the fact that we were seeing inflationary pressures, which everyone in the industry is facing right now. And the fact that we were, at that point, in need of putting pricing in place and that’s what we were really clear that we were going to do. If you take a look at what’s happened in the marketplace, and I’ll just use IRI as an example. On a year-to-date basis, our price is up across our portfolio of CSDs about 1.9%. In the latest 13 weeks, it’s up 3.3%. That still lags the category but we’re now catching up. And that's really what's required for us to close that margin gap on the packaged beverage side of the business. And so if being implemented not a lot of that hit during the quarter. So the benefit to your question will really hit us in Q4 and then roll over into 2019.

And then just a follow-up on the margin or the process improvement at KGM side, so I think you also called out lower marketing expenses. So of the 22% increase in operating profit, how much was the lower marketing? And is this more timing that hit the fourth quarter? How should we think about that?

It’s really timing related, because there are some nuances around when you want to spend around the holiday season versus year ago, and it was not a significant driver in the profit improvement in the quarter. It was one of the smaller contributors to it and it’s nothing to signal other than just when do we want to time around the holiday. And we’re really happy with the advertising that we have on air right now with James Corden, featuring the new growers; looks great and is getting great consumer response to it. So we’re happy to invest in that in the fourth quarter.

A question for you on the innovation side, specifically on the legacy DPS business. I was just wondering if you could offer your thoughts on, or your perspective on where you take innovation as you go forward relative to prior DPS. And then relative to the coffee business where you had a longer lead time to get innovation out. How long you’ve taken to in innovation cycle that you feel is representative of what you can do going forward? Thanks.

We see many opportunities to expand into new areas within our portfolio on both sides of the business. As we have discussed before, our partnership strategy is vital, but it’s not the only method we have. There is a significant chance for innovation and improvement. A great example is Canada Dry; it's a solid segment with strong marketing support, especially with the introduction of Canada Dry with lemonade this year. Reviewing the year-to-date figures, that business is up around 16%, and it has actually done even better in the most recent four weeks. This clearly demonstrates how effective marketing and enhancements to an existing product can drive growth. Our view is that we will take a balanced approach to ramp up growth across the business. Additionally, achieving 16% growth on a carbonated soft drink like Canada Dry is likely surprising to many, given the perception that CSDs are flat to declining. This encourages us that we can truly increase growth in this area.

So just to start a couple of just cleanup clarification questions, I guess. On the guidance, I get the EPS has been reiterated. Just want to confirm that you're also reaffirming the 7% to 8% EBITDA growth. Second on the A&P, I think you did a good job of clarifying the timing related. Just as we think about the full year pro forma. Are you net investing in A&P, or is A&P down, is it a source of profit growth in the year? And then last on the synergies. Is any benefits to 2018, because obviously we're not carrying the executive management team at DPS any longer. And I think as of a couple of weeks ago, there has been a pretty sizable restructuring done in Plano. So just want to understand if there is synergy benefit to '18?

We will divide responsibilities on this. I will handle marketing since it’s the simplest aspect. Marketing will not decline year-over-year; it does not contribute to our profit. In fact, we aim to increase productivity to invest more in our brands, which we expect to see moving forward. The evidence of growth in the Dr Pepper, Canada Dry, and Keurig businesses gives us confidence that we are willing to invest in the right marketing channels. Ozan, could you discuss the synergy aspect? Please share how we view the synergies and their impact on 2018, and then I will ask Maria to discuss our targets.

In fact, the synergy that we are going to see in 2018 would be quite a bit immaterial. And we ordered the new and it was related to a handful of executives with regards to the severance, and the consequence of that, the synergies that we had already planned, and literally quite a small number. That's why we did not change our outlook, neither for 2018 nor for 2019. And we basically say, as I said during 10 minutes of readout that we are committed to deliver our synergy number $600 million over three years, so starting $200 million 2019 onwards.

And Stephen, regarding your question about the recent restructuring we announced, that was right on schedule from our original plans. The timing was late in the year, and by the time people actually read about it, it will have almost no impact in 2018, but it positions us well along with other synergies for 2019. Maria, do you want to discuss the target question?

I know you asked about EBITDA, let me just start at sales. We disclosed net sales and that’s going to be in the plus 1% to 2% range for the year. Originally, we were talking about EBITDA in the 7% to 8% range. We've since gone to EBIT, because as a public company, we think EBITDA is far more important in our operating income, it's much easier for other folks to track. But the difference between the growth rates is insignificant. So we’re still looking at 7% to 8% growth in operating income. And Ozan already talked about $600 million in synergy, which was another important metric. So I think we’re holding our guidance and all of the important elements of that guidance we are not changing.

If I could ask one more question, as a follow-up, when we consider the cultural synergies from legacy DPS, there has been a significant effort over the past five to seven years to implement what is known as rapid continuous improvement. I'm curious about how you have engaged with the DPS team regarding this program. What have you found, and do you anticipate it will continue? How should we view its role going forward?

Clearly, productivity, it's been a big part of both companies' cultures. There is different approaches to it, different names behind it and look at the productivity delivery prior to the merger with DPS. If we saw the before and after picture when it was private and then public again, you saw that was a very significant amount of productivity driven. So, I think it’s great that we are all working together towards the same goal. These are both organizations that have an appreciation for the fact that the way to control your destiny in CPG today is to make sure that you've got robust productivity that you can invest back in the brands and into your organization where needed. And so that part has been, I would say, fairly seamless in terms of the cultural fit.

I wanted to start with the KGM business and come back and build on Bryan's question, and then I have a question on working capital. So Bob, just to come back to the pricing dynamic and you sound relatively comfortable with that. Have we flattened out at this point? So in other words, are you comfortable modeling flat pricing looking out to '19. And then as it pertains to that, when the deal was announced, the expectation was at least at the time the KGM gets back to 2% to 3%, or 2% or 3% type growth in 19 and beyond, things certainly getting better sequentially each quarter this year but not certainly not at that 2% to 3% level. What's your confidence that you can deliver on that 2% to 3% looking out to next year? And then I'll follow-up with the working capital question.

I believe we still need to approach pricing with caution. While I wouldn’t describe it as moderating, I would characterize it as flat at this moment. This seems to be the wise planning strategy. It compels us to make informed decisions regarding productivity to maintain our margins. This approach also places us in a strong competitive position because, as I mentioned earlier, lowering prices draws more consumers into our system and satisfies our partners. The targets we established at the beginning of the year when we announced the deal remain very much in place, as Maria previously discussed, and I think all the components of the KGM strategy and KGP as a client company are aligning well.

So 2% to 3% but then more volume weighted and you guys can offset the lower price that you’re still confident with that. Is that correct?

We believe we can manage different pricing and volume strategies effectively. Overall, we are in a good position.

And then quick follow-up for Ozan on working capital. There is clearly a healthy level of working capital improvement based on your leverage guidance looking out, but not to the degree that you're able to achieve on the Keurig side. Now that the deal is closed and you've spent quite a bit of time now with the operations. Do you see potential upside for working capital at this point or is that something that you can comment on?

And as we’ve said, we’ve successfully developed our working capital in the past doing healthy and into legacy KGM. And it's basically we are applying the same to the table, using even the larger balance sheet. And we feel very good about in terms of the working capital generation levels, why is this turned into cash that we have found out so far in DPS legacy. So we feel very good about it.

Yes, if I’m not mistaken, the Keurig side had a decline of 15% in sales. Is a similar outcome achievable on the legacy Dr Pepper side?

Yes, we will be pretty close to that number somewhere around, as you said, minus 12% to minus 13% is within range. And we have already started to deliver on the trajectory based off the working capital improvements that we managed to do in the past 84 days.

First question, I was wondering if you could just give us a little bit more background in terms of color on Bai, what strategy is there. You’re taking a little bit of price reductions. What’s going on there in terms of volume, penetration, distribution, velocity, anything to give us a sense of what’s going on with that brand please?

Bai has transitioned from a small but fast-growing brand to a more established one, currently in the $400 million range and growing at 15% year-to-date. While it's good news that the brand is larger now, it's important to acknowledge that rapid growth rates of 40% or 50% are not sustainable, especially as it approaches the half-billion-dollar mark. However, we see significant long-term potential for the business, particularly with further distribution opportunities in smaller outlets. Looking at IRI numbers, there are still notable distribution gaps in those channels that should continue to support growth for the brand moving forward. We're pleased with its progress, as it adds value to our portfolio and contributes meaningfully to both revenue and profits.

And what’s the pricing strategy?

The pricing you are seeing includes some negative pricing, which is really just a quarterly timing issue related to promotions. It's not a deliberate strategy to reduce prices, as we previously mentioned regarding pods. This is simply a timing matter related to promotions that affected the pricing.

And then my final question, I'm also hearing that there is out there a second increase on 20-Ounce PET, The Coca-Cola Company is trying to lead in c-stores. Are you guys following that? Do you have any sense or color on what's going on there?

I mean that’s not something that we could comment, which would be future pricing that’s rumored would be appropriate for us to talk.

This is Gerald Pascarelli on for Vivien Azer. Thanks very much for taking the question. So my first question has to do with the coffee systems. The 8% volume growth that you delivered in Brewers, I guess. What percentage or how much did the new innovation from K-Café, K-Latte drive the growth relative to your more core offerings?

I have to look that one. I don’t have that off the top of my head. It's really just started shifting during the quarter. It's really going to hit mostly in the fourth quarter. And so that’s where you will see much more and we will clearly have that answer on our next call. But I think it's mini, the latte and the Café are really going to be a big driver in the fourth quarter, not as much in the third quarter.

And my next question has to do with Canada Dry. I know that Ginger Ale, strong performance in Ginger Ale was a call out in the prepared remarks. But I guess where does Sparkling Water fit into the growth profile and into the brand's overall performance here as you continue to deliver these strong trends? Thank you.

We think that Sparkling Water, under both Canada Dry and Schweppes has been a big growth driver. It's not something that shows up on a lot of these numbers nor that we talked a lot about it. It’s a relatively small business but there are regions in the country where it's fairly large. But again when you think about our go forward strategy that’s the segment that really would be a good addition to our portfolio in a broader way than we have played right now with Canada Dry and Schweppes; but there are pockets of country, particularly in the northeast where it upsells other sparkling flavored waters and I think it's something that we haven’t leveraged well enough.

The question is really on M&A. You obviously have made some moves on brands. But I'm curious how you think about acquiring different go-to-markets, because it does seem like just looking across the entire beverage landscape, distribution is starting to become more of a focus just as companies try to get closer to the consumer. So, maybe you could just provide some context around that?

Just to clarify, are you saying acquisitions related to distribution versus brand?

Yes, the focus is on go-to-market strategies. It's about asset purchases compared to brand purchases, or perhaps there's a combination of both.

I'll do the question. I think anything is fair game as we think about optimizing our business. As we talked about our strategy, it’s a combination of broadening our portfolio and making sure that our distribution and merchandising is best in class. We think about the portfolio side, as I've said before, a combination of innovation, renovation, as well as partnerships and M&A. On the distribution side, we're thinking about things, I think more towards optimization of what we have right now and we've got number partnerships right now in the distribution space that we also think it we could have conversations that are more strategic in nature as well. I wouldn’t rule that out what you’re talking about, but it's certainly not on our short-term hit list of priorities that we think that we can get a significant amount of improvement in the market system by optimizing what we have and maximizing the relationships that are in place right now.

I’m curious about how much partnerships or additional brands are included in your algorithm, or if it's based solely on what you currently have in your portfolio.

I think as we talked about that those targets, which we go back to as we put out there at the time of the announcement of the merger before we knew exactly what Allied brands would look like. And as we said a number of times that’s what you guys have us forced to navigate through all these complexities to make sure that we're able to land in a very good place, which is exactly what happened where we stand today with the Allied brand portfolio, and I talked before about how we think the impact on the business, going forward. We like partnerships so we will continue to do those, and we will continue to add through acquisition as well. And if it got to a point where it was such a material addition to it that it would change our outlook, we have that conversation. But we feel like we’re in good position right now with the partnerships in place and the portfolio that we have to deliver well against the targets that we talked about all the way back to January.

This is Maria. I just want to thank everyone for joining us tonight. I know it's getting late. We will be around. So if anyone wants to reach out to me, certainly feel free to do so. Steve Alexander is also here, so reach out to him as well. And thank you for participating and we look forward to continuing the dialog. Take care, everyone.