Keurig Dr Pepper Inc (KDP) — Q3 2019 Earnings Call Transcript

Thank you, and hello, everyone. Thanks for joining us. Earlier this morning, we issued our press release for the third quarter of 2019. If you need a copy, you can get one on our website at keurigdrpepper.com in the Investors section. Consistent with previous quarters, today we will be discussing our performance on an adjusted basis, excluding items affecting comparability, and with regard to the year-ago period. Our financial performance also takes into account pro forma adjustments due to the merger. The Company believes that the adjusted and adjusted pro forma basis provide investors with additional insight into our business and operating performance trends. While these pro forma adjustments and the exclusion of items affecting comparability are not in accordance with GAAP, we believe that the adjusted and adjusted pro forma basis provide meaningful comparisons and an appropriate basis for a discussion of our performance. Details of the excluded items are included in the reconciliation tables in our press release and our 10-Q, which will be filed later today. Due to the inability to predict the amount and timing of certain impacts outside of the Company’s control, we do not reconcile our guidance. Here with me to discuss our third quarter 2019 results and our outlook for the balance of the year are KDP Chairman and CEO, Bob Gamgort; our CFO, Ozan Dokmecioglu; and our Chief Corporate Affairs Officer, Maria Sceppaguercio. And finally, our discussion this morning may include forward-looking statements, which are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of key 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 the risks and uncertainties is contained in the Company's filings with the SEC. With that, I'll hand it over to Bob.

Thanks, Tyson, and thanks to everyone for dialing in. Before diving into the discussion of the quarter, I wanted to take a moment to share the overall value creation model for KDP that we frequently discuss in our investor meetings. While we always have a number of detailed items that we cover in our quarterly earnings calls, it’s helpful to remain focused on the key drivers of value, which are fairly straightforward. We created KDP with a mission of providing consumers with a beverage for every need, whether hot or cold, available everywhere they shop and consume. We set ambitious three-year goals for both top and bottom lines, to grow revenue 2% to 3%, operating income 11% to 12%, and EPS 15% to 17%, fueled in part by $600 million of synergies and free cash flow conversion in excess of 100% to enable rapid deleveraging to below three times. In cold beverages, we lead the non-cola CSD segment and have meaningful positions in a number of high growth and on-trend cold beverage segments. For example, we're the number two player in premium water. We're also one of three companies with near national retail reach to our direct store delivery system. We create value by renovating and innovating our portfolio to leverage that selling and distribution powerhouse and by partnering with emerging growth brands that offer access to new segments and a clear path to ownership. Productivity provides funding for our brand marketing and innovation. In Coffee Systems, we create value through expanding Keurig system household adoption by converting drip consumers to single serve. Keurig brewer innovation combined with effective system marketing drives that conversion. Unique to Coffee Systems, we share productivity with our partners to lower the price of K-Cup pods, further driving consumer growth while still continuing to expand our margins. Across the enterprise, we drive exceptional free cash flow that enables us to delever and offer shareholder value optionality in the future. With five quarters behind us as an integrated company, we demonstrated that our value creation model is working with significant potential still in front of us. With that as perspective, let me now turn to the third quarter results. All four of our segments again registered underlying net sales growth and we continue to perform well in the marketplace, growing dollar consumption and market share in a number of our key categories. This top-line performance, which was balanced between volume mix growth and positive net price realization, along with synergies and productivity, drove another quarter of strong underlying adjusted EPS growth of 13%, excluding a 6 percentage point year-over-year headwind from lapping one-time gains in Q3 last year, which Ozan will discuss shortly. Our cash flow generation also remained very strong, enabling us to pay down $423 million of structured payables and reduce debt by $71 million in the quarter. To date this year, we have generated over $1.6 billion of free cash flow with our cash flow conversion at an impressive 130%. We continue to build our roster of brand partnerships by agreeing to a long-term master licensing and distribution agreement for McCafé packaged coffee in the U.S. You may recall that we agreed to a similar arrangement with McCafé in Canada in Q4 of 2018. The U.S. McCafé agreement will go into effect during the second half of 2020. While McCafé was previously a partner brand in the Keurig system, this new licensing agreement gives us the added responsibilities of coffee sourcing, manufacturing, distribution, selling, and marketing the brand in all forms across all channels. This new agreement is a testament to the strength of the overall Keurig system and KDP's capabilities in coffee. Retail market performance based on IRi was again solid in the quarter. We grew dollar consumption and market share in several of our key categories including CSDs, premium water, shelf-stable fruit drinks, and shelf-stable apple juice. This performance reflected the growth of key brands such as Dr Pepper, Canada Dry CSDs, CORE Hydration, Snapple juice drinks, and Motts apple juice. As is always the case when managing a broad portfolio, we have a few categories that require additional focus. Falling into that territory are Bai, Snapple Teas, and the ramp-up of new Allied Brands. We believe we have good line of sight to improve performance across all three of these areas, which I’ll speak to in a few minutes. In our U.S. coffee business, volume consumption of single-serve pods manufactured by KDP grew approximately 2% as measured by IRi, which we know greatly understates actual growth. As we discussed at our recent conference, which reported in the tracked channels only represents about half of our total K-Cup pod business, with untracked channels, particularly e-commerce, experiencing higher growth rates. For comparison, our pod shipment growth in the third quarter was 6.1%, and over the past 12 months, K-Cup pods have grown 8.6%. These growth rates are more representative of the broader category growth. Dollar market share of KDP manufactured pods in tracked channels remains strong at 81.4% in the latest 52-week period. In terms of high-level financials on an adjusted basis, our underlying net sales, which exclude the movements in and out of our portfolio of Allied Brands, grew 3.1%, with growth from all four segments. This performance reflects the strength of all mix growth and higher prices to net price realization. In addition, we also had a modest benefit from an extra DSD shipping day in our Packaged Beverages segment. Adjusted operating income grew 8% in the quarter, reflecting the strong underlying net sales growth, productivity, and merger synergies, partially offset by inflation primarily in packaging and logistics. Operating income growth would have been even higher, if not for the unfavorable comparison versus a year-ago of a one-time gain related to the Big Red acquisition. Ozan will cover the details of that later in the call. The underlying adjusted EPS growth of 13% reflected our balanced top-line growth and operating income performance, along with the benefits of continued debt reduction and a lower effective tax rate. All key tenets of our three-year merger targets. Turning now to our segments. Starting with Coffee Systems, net sales increased 1.1%, fueled by higher volume mix of 3.1%, partially offset by lower net price realization of 1.9% and unfavorable foreign currency translation of 0.1%. The higher volume mix for the segment was driven by pod volume growth of 6% and brewer volume growth of 8%, partially offsetting the growth in buying this quarter was lower pod mix, reflecting the mix impact of higher shipments to brand partners for whom we only record a tolling fee. As we enter the important retail holiday season for brewer sales, our new lineup of K-Duo brewer is now fully on shelf and performing very well. As you recall, the K-Duo line of brewers provides consumers the ability to brew a large pot of coffee through a traditional drip system in addition to a single cup of K-Cup pods. The line is receiving great consumer reviews online, and we are excited about the incremental household that they will unlock. The K-Duo lineup is being supported with increased marketing across traditional and digital media platforms and continues to feature James Corden as our brand ambassador. Consistent with our discussion on our last earnings call, we expected Q3 to be a bit out of sync, which is exactly what transpired. Adjusted operating income declined 3% due to a mismatch this quarter in the timing of pricing, inflation, and brewer investments, including media, market research, and innovation development costs, compared to the positive offset of productivity and volume. As we’ve discussed consistently, the nature of this business leads to volatility in results from quarter to quarter, but when viewed over a slightly longer timeframe, the growth we continue to drive becomes quite clear. For perspective, on a trailing 12-month basis, K-Cup pod volume advanced 8.6%, total Coffee Systems operating income grew nearly 5%, and operating margin expanded 100 basis points. Quarterly results have fluctuated both above and below these numbers sometimes meaningfully; however, we remain focused on the real underlying drivers of growth. Turning to the Packaged Beverages segment, reported net sales for Packaged Beverages were again significantly impacted by the unfavorable impact from the changes in our Allied Brands portfolio, which amounted to a 5.8% segment headwind in the third quarter. Excluding this impact, as well as the 0.6% benefit we have from an extra DSD shipping day, underlying net sales grew a healthy 3.1% in the quarter, driven by net price realization of 2.7% and a higher volume mix of 0.4%. As mentioned previously, the impact from our Allied Brands will switch from a headwind to a tailwind in the fourth quarter and represents a top-line driver in 2020. Driving the 3.1% underlying net sales growth for Packaged Beverages in the quarter were Dr Pepper, Canada Dry, and CORE Hydration, the latter of which continues to register very strong growth with an over 30% increase in retail sales in the trailing 52 weeks. In the case of Canada Dry, double-digit net sales growth was driven by successful innovation launched earlier this year as well as strength in the core brand. The Fansville College football campaign behind Dr Pepper is also in full swing, delivering strong results for our flagship CSD brand. The campaign is resonating well with consumers and is driving additional in-store displays, higher inventory on display, retail dollar growth, and volume performance that continues to outperform the category. As we enter the championship drive with the college football season, the campaign will feature new media content, on-pack consumer offers, strong in-store execution, digital and social media, as well as the return of our college tuition giveaway program. We are also rolling out our green bottle campaign with a handful of brands including Canada Dry in conjunction with the holidays. This campaign is always well received at retail, and we expect to provide good support behind our brands during a key selling season. Also contributing to underlying sales growth in the quarter were Motts, Sunkist, and A&W, as well as contract manufacturing. As mentioned earlier, there were a few areas where we see performance trailing our expectations. Bai, Snapple Tea, and some of the new additions to our Allied Brands. Bai performed below the category in the quarter, and we are implementing a number of programs to address performance, which we will share with you early in the New Year. While we have regained Bai distribution that had been lost in Q2 of 2018, we’re not experiencing the lift and velocity expected behind our marketing. As we close out this year and head into 2020, our focus behind Snapple Tea will be on brand renovation. And finally, let me touch briefly on our Allied Brands portfolio. To refresh everyone’s memory, we had significant changes in the Allied Brands portfolio at the time of the merger, hence our discussion since that time of the concept of underlying net sales. As we said on previous calls, the negative comparison to a year ago of Allied Brands turns to a tailwind in Q4 and is no longer a factor as we enter 2020, which will enable us to drop the discussion of reported versus underlying growth. Our total Allied Brands portfolio generates approximately $350 million in retail consumption and represents 3% of our cold beverage sales. While not large in the absolute, we expect these brands to provide access to higher growth segments. To that point, the ramp-up of the new brands to the Allied portfolio is progressing slower than expected. The reasons are slightly different for each brand, but in total we see a delayed response in realizing the full growth potential of these brands. As a result, we now expect the year-over-year net changes in the Allied Brands portfolio to result in a headwind to total KDP net sales of approximately 200 basis points versus the 100 basis points forecasted at the beginning of the year. The great news is we expect KDP's total underlying sales growth to approximately reach 3% for the year, which is at the high end of our target, driven by very strong growth on our own brand that’s been able to offset the slower start on Allied Brands. We also continue to plant seeds to support future growth such as A Shoc Smart Energy drink, which, while still quite early, is performing well in the market. We’ll discuss more about that in early 2020. Operating income for packaged beverages in the third quarter advanced a strong 23%, largely reflecting the growth in underlying net sales, strong productivity and merger synergies, as well as the timing of marketing spending, partially offset by inflation, particularly in packaging ingredients and logistics. And finally, we expect to exit the fourth quarter this year with strong sales growth that will fuel our momentum into 2020. Turning now to the Beverage Concentrate segments, which represent sales of concentrates to bottlers and syrups to fountain customers, net sales were up nearly 9% in the quarter, driven by both net price realization and volume mix growth. The strong volume performance was driven in part by our fountain food service business and is reflective of the strength in our core brands, such as Dr Pepper, Canada Dry, Sunkist, and Big Red. Operating income for Beverage Concentrates advanced a strong 20% in the quarter primarily reflecting the strong growth in net sales, as well as merger synergies and productivity. And finally, turning to Latin America beverages, net sales for the segment increased 1.5% in the third quarter, and operating income of $25 million declined slightly, resulting from higher marketing spending and inflation. With that, I'll hand it over to Ozan.

Thanks, Bob, and good morning everyone. I will start with a review of the financials for the third quarter, which was a good one for KDP. I will then transition to our outlook for the balance of the year, continuing on an adjusted basis. Net sales for the third quarter increased 0.5% to $2.87 billion compared to $2.86 billion in the prior year. This performance reflected strong underlying net sales growth of 3.1%, driven by higher volume mix of 1.5% and favorable net price realization of 1.6%. Also in the quarter, we had an additional shipping day in our Packaged Beverages segment, which added 0.3% to the growth, partially offsetting the underlying net sales growth and the extra shipping day was the unfavorable impact of 2.7% from changes in our Allied Brands portfolio, as well as unfavorable foreign currency translation of 0.2%. On a constant currency basis, underlying net sales increased 3.3%. Operating income in the quarter increased 8% to $754 million compared to $698 million in the prior year. This increase reflected strong underlying net sales growth and continued productivity and merger synergies in both cost of goods sold and SG&A. These growth drivers were partially offset by inflation led by packaging and logistics, and the unfavorable comparison versus the year-ago to the one-time $6 million gain related to the acquisition of Big Red. Operating margin advanced 190 basis points in the quarter to 26.3%. In terms of our segment performance for the third quarter on an adjusted basis, net sales for Coffee Systems increased 1.1% to $1.07 billion in the quarter compared to $1.05 billion in the prior year. This performance reflected higher volume mix of 3.1%, which was partially offset by lower net price realization of 1.9%. The volume mix performance was driven by strong brewer volume growth of 8% and pod volume growth of 6.1%, despite the previously discussed shift of certain pod shipments from the third quarter of 2019 into the second quarter. As Bob discussed earlier, the strong pod volume growth was partially offset by unfavorable mix reflecting the impact of higher pod shipments to our brand partners in the quarter. Unfavorable foreign currency translation of 0.1% also impacted net sales in the quarter. Coffee Systems operating income was down in the quarter as expected; specifically, operating income declined 3.4% to $367 million compared to $380 million in the prior year, reflecting unfavorable mix, lower pricing, inflation in packaging and logistics, and higher growth investments including media, market research, and innovation development costs. We are also lapping the timing of certain adjustments in the prior year related to legacy Keurig Green Mountain's year-end including bonuses and stock compensation, partially offsetting these factors were strong volume growth as well as continued productivity and merger synergies. Operating margin in the quarter was 34.5%. Moving to packaged beverages, net sales for the segment decreased 2.2% in the quarter to $1.31 billion compared to $1.34 billion in the prior year. This performance reflected strong underlying net sales growth of 3.1% driven by the higher net price realization of 2.7% and increase volume mix of 0.4%. Additionally, the extra shipping day in the quarter had a favorable impact of 0.6%. More than offsetting these growth drivers was the unfavorable impact in the quarter of 5.8% from changes in the Allied Brands portfolio and unfavorable foreign currency translation of 0.1%. Operating income for packaged beverages increased 22.6% to $201 million in the third quarter compared to $164 million in the year-ago period. The performance reflected continued productivity and merger synergies, strong underlying net sales growth, and the timing of marketing investments. These positive drivers were partially offset by inflation in packaging, ingredients, and logistics. Operating margin was up 310 basis points versus the year-ago period to 15.4%. Turning to Beverage Concentrates, net sales for the segment increased 8.8% in the quarter to $360 million compared to $331 million in the prior year. This performance was driven by higher net price realization of 6.5% combined with its favorable volume mix of 2.3%. The strong net sales growth in the quarter was driven by Dr Pepper, Canada Dry, Big Red, and Sunkist. The shipment volume increased for Beverage Concentrates primarily due to Dr Pepper and Canada Dry, Big Red, and Sunkist. In terms of bottler case sales volume, Beverage Concentrates increased 2.1% compared to the year-ago period. Operating income for Beverage Concentrates increased 19.6% to $244 million compared to $204 million in the year-ago period. This performance reflected the benefit on net sales growth, strong merger, and productivity, operating margin advanced 620 basis points versus the year-ago period to 67.8%. Turning to Latin America beverages, net sales for the segment increased 1.5% to $138 million compared to $136 million in the prior year. This performance was driven by higher net price realization of 5.2%, partially offset by lower volume mix of 1.5% and unfavorable foreign currency translation of 2.2%. On a constant currency basis, net sales increased 3.7%. Operating income for Latin America beverages totaled $25 million in the second quarter compared to $27 million in the year-ago period. This performance reflected the net sales growth and productivity, which were more than offset by inflation in logistics and ingredients, as well as increased marketing investment. Turning to interest expense, interest expense in the third quarter declined $17 million or 10.5% to $145 million and was driven by our continuous deleveraging. Net income for the quarter increased 8.2% to $451 million compared to $417 million in the prior year. This performance was driven by strong operating income growth, lower interest expense, and a lower effective tax rate compared to the year-ago period. Partially offsetting these favorable drivers was an unfavorable comparison to the prior year to the $24 million gain from BODYARMOR. This gain, along with the previously mentioned $6 million gain related to the acquisition of Big Red, collectively reduced the year-over-year net income growth rate by approximately 6 percentage points, translating into underlying net income growth of approximately 14%. Taking all of these factors together, our adjusted diluted EPS in the fourth quarter increased 6.7% to $0.32 compared to $0.30 in the prior year. On an underlying basis, adjusted diluted EPS was 13%. Free cash flow was again strong in the quarter, driven by growth in net income and continued expected working capital management. As a result, in the fourth quarter, we paid down approximately $423 million of structured payables and reduced net debt by an additional $71 million for a total of $494 million in payments. This increased the total amount of debt paid down in the first nine months of 2019 to $788 million, as well as the reduction in structured payables of $188 million. For the first nine months of 2019, we generated over $1.6 billion in free cash flow with a free cash flow conversion rate of 130%, and exited the quarter with $74 million of unrestricted cash on hand. The debt reduction in the quarter, along with our growth in adjusted EBITDA, reduced our debt to adjusted EBITDA ratio, which we refer to as our management leverage ratio to 4.8 times. This attractive pay-off delisting continues to be consistent with our expectations. And for perspective, since the merger close, we have paid down a total of over $1.7 billion of debt. And finally, in terms of our outlook for the balance of 2019, for the full year we continue to expect adjusted diluted EPS growth in the range of 15% to 17%, representing $1.20 to $1.22 per share. This guidance is in line with our long-term merger target. We continue to expect net sales growth of 1% to 2%, with underlying net sales growth now expected at approximately 3%, the latter of which is at the high end of our long-term merger target of 2% to 3%. This net sales growth reflects higher than expected growth from the core business and the slower ramp of the new Allied Brands, resulting in an approximate 200 basis points headwind impact from the changes in the Allied Brands portfolio. We continue to expect merger synergies of $200 million in 2019, which is consistent with our long-term merger target, and we continue to expect these synergies to fully flow through to EPS. We continue to expect interest expense to be in the range of $550 million to $565 million; this reflects our expectation of significant cash flow generation and continued deleveraging, as well as the first-half benefit in 2019 totaling $40 million from the unwinding interest rate swap contracts. We continue to estimate our effective tax rate for 2019 to be in the range of 25% to 25.5% for the year. We continue to expect our diluted weighted average share to approach $1.42 billion in 2019. While we do not provide EPS guidance by quarter, I remind you that we expect quarter four EPS growth to be tempered by the significant one-time gains of approximately $17 million related to the core acquisition in 2018. We continue to expect our second-half synergies to be greater than our first-half synergies. We continue to expect inflation to moderate somewhat in the second half. Finally, in 2019 we continue to expect free cash flow to be approximately $2.3 billion to $2.5 billion, and with this strong free cash flow generation, we expect our management leverage ratio to be in the range of 4.4 to 4.5 times by the end of 2019. We also remain confident that we will achieve our leverage target of below three times in two to three years from the July 2018 merger closing. And with that, I will hand it back over to the operator to open it up for your questions.

Just two questions from me. One, Ozan, on the free cash flow conversion, this year you're over 130%, and I think what would be implied in terms of getting to the leverage target, the multi-leverage target that you can maintain a pretty high level of free cash flow conversion. So can you just give us a sense of whether or not where you stand today at converting over 130% is still sustainable? Or is there some reason why it would be maybe different going forward? Then I've got a follow-up.

Good morning, Bryan. In short, yes, the answer to your question; right now for this year, as we announce the conversion ratio is 130. Of course, there are lots of puts and takes, and as we discussed before, our effective working capital management was the main reason for getting over 100, but we still have continuation of our program into 2020 as well as 2021, and we are also, as we always do, after seeing the opportunities and exploring the new initiatives, which we expect actually our conversion ratio to be closer to around give-and-take 100% conversion. And if you can do better, of course we will do better, but the conversion ratio will be high in the upcoming two years.

And then, Bob, on the brewer lineup, going into the holidays. If you go back to the investor day, you talk about sort of the bridge to build household penetration from that point about 20% and it was quality, modernizing, making it more convenient, variety, value, right? There were a whole sort of cost of levers that would drive penetration, and it just seemed at this point you've got all the brewers renovated with the new engines, you got to do over the market, which is more convenient. It just seems like you've kicked off a lot of those different levers. So can you just update us on how you're thinking about the brewer lineup today? Those sort of clusters, and what it might imply for beginning to accelerate household penetration?

Sure, you're referring to the waterfall that we showed in the investor day, where we identified the opportunity to convert households in the range of about 60 million households. Then we built on that, showing the research as to why people who theoretically should be in a single serve coffee system warrant. And then we redesigned our brewers and our marketing plans to specifically go after those barriers. So job one was to increase the quality of the brewers, hit the right price points, and then begin to add features. As you accurately point out, we've been ticking off many of those opportunities, modernizing the look, going in the specialty beverages with the K-Café, and now very importantly, going after one of the biggest barriers, which is the ability to produce a large batch of coffee with K-Duo. So I would tell you as we sit here today, the quality of the brewers is up significantly; you don't have to take my word for it, you can just look at the star ratings online. We’ve been able to nail a lot of the basics, hitting the lower-end price points. We’re now moving to the higher-end as well and then filling out most of the functionality that we talked about. And so we’re really happy, and that’s what’s driving the strong household penetration that we continue to experience, but we’ve got a great pipeline still ahead. There is still a lot of white space to fill in between all of those, and there are new features and benefits that we can add to existing brewers to make them even more interesting that we'll share with you in the coming months. So, we feel like we've got the basics in place, but a lot of upside still left. And then I would also remind you that there are drivers of household penetration that aren’t directly connected to the brewers, and one of the biggest is having a recyclable pod. And so that is being implemented as we speak and will be completed by the end of 2020. And just to give you one final point, we get a lot of questions regarding how everyone is launched for brewers, so you got everybody, so you’re going to get based on that into the system. It takes time. People don’t typically replace their brewer until their current brewer breaks. And so, we have to layer on lots of different features and benefits to get people, and it really is a slower build than one might think. But it’s all moving in that direction, and that gives us line of sight to growing household penetration for quite a long term.

Hey, I wanted to ask a little bit about the Allied Brands, so I’m assuming the slower ramp is about the market performance, is what you already have in the portfolio, not a matter of attracting more. I’m sure that's a different story for different brands, but anything you can offer as to sort of the health of the established brands that you brought in-house? Is it noise that sort of the newer segment that you’ve been entering? And I know this is a short-time period, but is this performance sort of impacting at all your thinking about portfolio composition for the Allied piece as you go forward?

Yes. Let me give you a couple of thoughts on that, Lauren. I think first of all, as I mentioned, the total Allied portfolio is now about $350 million in sales. So, it's important, but it's not as large as it once was. That number may be surprising because you might think, well, I thought that number was much larger than that. And the reality is it was, but if we recall, we acquired some of those businesses. So, if you look at the core and the Big Red businesses that we acquired in the past year, they actually are larger than the remaining Allied Brand portfolio that we have left. So, it’s still a good opportunity for us to access different segments and different levels of growth, but in its absolute sense, it’s not as important as it once was. We talked about the net change in Allied Brands with FIJI and BODYARMOR coming out and some of the new ones coming in, evian, Peet's, and FORTO. We said that was about a 100 basis point headwind, and now we’re saying it's about a 200 basis point headwind. Look, if you take a rounding in that, it was slightly more than that rounded down to a 100 and slightly less than that rounded up to 200. What we’re talking about here is a delay in sales versus our expectation of about $50 million. So, it has an impact on our growth rate for sure, but the good news, as I emphasized before, is that we’ve been able to offset that with real strength in our core owned businesses, which speaks to the health of that portfolio. As we sit here today, to answer the part of your question, and we look at those new brands, we think it is primarily just a delay. It's just a slower startup. We're getting the distribution. The velocity is building. It's just not the rate that we thought it would be, and it's a combination of things; when you're looking at new brands, sometimes it's hard to forecast. Evian is a good example; if you look at the latest 13 weeks, we're growing evian at about 8%, which is below the categories because the category is really strong. The category has grown at like 12% to 13%, but 8% is not too bad; it's up significantly. So, we're seeing traction; it's taking longer to get there, and it really doesn't affect the way that we think about Allied Brands going forward. And as I remind you, we will also continue to put new partnerships in place, like A Shoc, that will continue to fill that pipeline. So, I think this is well contained and well defined and really doesn’t change our outlook going forward.

I wanted to drill into Beverage Concentrates if I could. The performance there was really strong in this quarter, and price realization seems to be the key driver in both sales and segment margins. Is there anything you're doing differently in that business this year, perhaps, with respect to promotional depths or breadth to drive that kind of price realization, seemingly without any real degradation of volumes? And if so, what's the runway on that source of profit growth continuing? Is this a one-year step up, or are you expecting more normalized growth to resume in the year ahead? Or do you see more incremental opportunity available to you in 2020 and beyond?

It's hard to know what price realization going forward is going to be, to be honest with you. I mean, that’s very much driven by the industry in total and other factors like inflation. So that's still to be determined. What you're pointing out is very important; the strength of our brands that are sold as a Beverage Concentrates segment allows the pricing to be put in, and yet the volume holds up nicely. And remember, these are the sales primarily of brands like Dr Pepper, Canada Dry, and then we've got others like Crush, and Schweppes that go through and are sold by either Coke or Pepsi, but also a very important channel of Fountain Foodservice, which is restaurants. As we point out a number of times, Dr Pepper is actually the most available brand in the country in Fountain Foodservice. So, the brand it's a concentrated portfolio of brands with incredible strength. That's why we continue to invest heavily in marketing behind these brands. They are able to withstand the pricing, and what you are seeing in the quarter is that pricing flowing through, that was taken sometimes with a bit of a delay to get that pricing. You’re seeing that matched up against the benefits of productivity and synergies across the entire business as a result of the integration, and that’s why you're getting such powerful profit increases during that duration. But it’s a very robust business to report about pricing, we will see; we take every opportunity we get going forward, but it's hard to have a forward-looking position on industry pricing.

Just to clarify then; this is reflective of true list price increases that you have taken versus your change in the promotional cadence, or is it a little bit of both?

When we're selling in the concentrates segment, yes, the answer is a little both, but when you take a look at the concentrates segment, when you think about pricing, it's different than what you think about it in our packaged beverages segment; we're actively involved in the promotions. And we’re selling to somebody else who turns around and resells our products in the beverage concentrate segment. So that’s why it’s more of a combination of it, but it's really more about the absolute pricing that we’re giving, and it is timing or level of discounting as you might see in a retail environment.

I have two quick ones. On Bai, what happens, I guess is the question, what do you think is really causing some of the weakness and the fact that it’s been lagging your expectations? So that would be the first one. And then the second one, Bob, is just, look, I think you guys have obviously done a very good job of integrating at a time when a lot of big mergers have not really done that well. And I’m just kind of thinking about future layers of value creation, and thinking about what’s been going on between Coke and Pepsi and your franchising and how it’s really worked for Coke? And I just wonder, is this an opportunity for KDP longer-term? Just wanted to get your thoughts on that.

Bai, I think is pretty straightforward. It was a pioneer in the category, it became the number one player by far, and there is a lot of competition - that's just CPG issues that happen every day. What do we need to do? We need to refresh the brand and drive it to the next level with innovation that we’ll keep ahead of the game. For perspective, when we talk about weakness in Bai, it’s still a business that’s about a $0.5 billion in sales, and on a 52-week basis according to IRi grew by 3%. So, it's not the brand is falling off the edge. It's just not growing at the level that we believe has the potential to grow. And so, it's going to be a combination of renovation on the brand and some innovation that we’ll continue to drive. And again, like I said, what we have, we’re going to share that with you in early 2020. With regard to your question about M&A more broadly, we’ve been very focused on taking the portfolio that we have today and making it work, and you’re seeing there is a significant amount of upside potential for the foreseeable. There will be a point in time when we’ll start thinking about M&A differently. You’re also talking about the we’re off to the market side of the business, refranchising and driving that. There is nothing that we would talk about at this point in time, but one of the big value drivers for us is to optimize the distribution system that we have today. And what that really means in the near-term is running more effectively, which is actually showing up in a lot of our numbers. And also, on the margins, bringing in routes from independent distributors, for example, where we see an opportunity to combine with our own route to get more scale, we’ll be doing that on the margins, but I will keep that as more fine-tuning on top of running the fundamental distribution systems we have right now better rather than a big strategic move like a one day that you’re referring to.

Given the pod volumes during Q2 and then this quarter, like the rebound, are there any channel inventory considerations into Q4? And is there potentially any upside, I guess in the full year outlook?

If you look at our pod volume over the long-term, it's been really solid. So, just to remind everybody, in 2018, pod volume was up about 7.5%. We’re running 8.5% on a year-to-date basis, and 12% basis to running about the same, about 8.5%. What we called out in the last call was the fact that we knew that we shipped ahead of consumption in the second quarter, 100% driven by partners who wanted to take volume earlier. To that, we were up 12.8%. We said we were going to get a reaction to that in our numbers in Q3, and we did, we were up six, which is below our long-term trend. Our assumption is when you look at Q4, as it all reverts back to the mean, and there is nothing notable to call out on that. And I think part of the learnings over the past 18 months or so, if you look at this business, it's a challenging business to try to forecast on a quarter-to-quarter basis if you are outside of the company. But when we take a broader view, and you don’t even have to go much longer than six months, but certainly if you go nine months or a year, it's a really steady and dependable business with some quarterly fluctuations. And so, our assumption in any situation that unless something notable that we will call out, you should assume that it just reverts back to mean.

Question really for both of you if you want to touch on this. So far, so good with the synergy delivery, and credit to you and your team for doing that, and you are still targeting. I take a step back and look at it; it's been closing in on two years since the deal was announced. You obviously had a much, much closer look at the different areas of synergy. So a couple of different questions, and Ozan, what do you see as potential upside, if any, to that initial target? And then Bob, for you, the target was a number that you expected to fully flow through to earnings. But as we've had this conversation in the call, Bai needs some attention and Snapple needs some attention, it's going to be a slower ramp with the Allied Brand, so there is an argument to be made that maybe investment levels need to move higher. Does that give you any cause to think the $600 million target needs to address some of it and should now potentially flow through to earnings?

Let me address the second question first, and then Ozan can explain where the $600 million is coming from. Regarding our level of confidence, we set these ambitious targets around two years ago, and a lot has changed since then. We needed to adjust for significant inflation increases and have observed pricing in the industry that negatively affected volume. The discussions about Bai and Snapple reflect normal business dynamics. Some brands perform well or exceed plans, like CORE Hydration, which is doing exceptionally well. However, there are also brands that require improvement. Overall, there is no conclusion to be drawn that indicates a necessary increase in spending or investment to address those issues. I aim to be transparent about what is working and what isn’t, while keeping you updated on our management focus. The key takeaway for you and our investors is that we established a long-term growth framework, emphasizing top-line growth of 2% to 3% and EPS growth of 15% to 17%. Our role is to navigate the changes in the marketplace, competition, and other external factors to deliver on these goals. We will utilize various strategies to counter some negative surprises. Importantly, our original growth framework remains unchanged, and the integration process is progressing very well, supporting this. Now, let me pass it to Ozan to discuss our thoughts on synergy as we move forward with the integration and the broader idea of value capture, which includes synergies and productivity in our internal discussions.

Sure. We are on track with our expectations to deliver $200 million in 2019, as we have guided several times, which also makes us to stay 100% behind $600 million of delivery over three years starting in 2019 through 2021. So that it stays as a rock-solid commitment, and we have great plans to achieve it. As Bob said, we also expect the synergy number to flow through fully in EPS. We started to deliver the synergies initially in SG&A, then procurement, and logistics following. Obviously, we have several initiatives that are fueling these deliveries, but I just - given the, let's say, big buckets of the areas of the delivery. And as Bob also said behind, besides the deal synergies, we also have several base productivity programs, as we call them internally, which have nothing to do with the deal synergies in both businesses that we have all built in our algorithm. We are also happy to share that we have been executing very nicely behind those initiatives as well.

That’s great. If I could just follow up with on one, Bob, maybe just touch on, you guys decide to make a small tweak to the guidance in early September and then another one to today. What happened I guess in the month of September that you felt incrementally more cautious on the impact from the Allied Brand but then incrementally better on the underlying portfolio, presumably as you move through September? Maybe you could just comment on that, I’ll pass it on. Thank you.

Yes, sure. I mean we talked that the 1% to 2% that we talked about back in September at an industry conference was a clarification of our position that we’re well known. People were struggling with trying to do the math on what the fourth quarter might look like. And so, we just decided to clarify. If you recall when we said just to clarify that our reported net sales will be in the range of 1% to 2%, consensus was around 1.4%. So, we saw that as a non-event that surprised us that people thought that wasn’t event. What we are seeing right now, which I think is important to point, is this is about the time period where the new Allied Brands should have kicked in at the higher level than they are. And I just want to put the size of that. On an annual basis, it's about $50 million. But again, the good news is that we’re seeing real strength in our core business. And that’s been able to offset that. That balance puts us in a position where we have confidence in a 3% underlying net sales growth for the year, which is a very strong number. And it's just the tweak between the Allied Brand and Core, which I think is a net positive. As I said earlier, I really think the Allied Brand number is more about timing than it is anything else. But when we get around 2020, we’ll talk more specifically about that.

Bob, I wanted to go back to your response to Steve's question on the sustainability of Beverage Concentrates segment. And I want to broaden it, not just Beverage Concentrates, but Packaged Beverages as well. Is it fair to read from your statement that these are good sustainable margin structures for these businesses as we go into 2020 and beyond?

Yes. I mean if you think about what we’ve been consistent in saying, which is 2% to 3% top line, 15% to 17% EPS growth, then yes, the implied in all of that is the margin structure that we have in place is solid and sustainable, and we'll benefit from the growth that we're talking about. In any integration, you get a boost from synergies. And as Ozan just talked about, we also look at ongoing productivity that's above and beyond the synergies, which helps fuel those margins, which you do get a point where the margins benefit from the synergies and when you are driving the business based on growth and the top line growth that we're pointing out to you is accelerating, which is driven by an underlying performance that’s about 3% served by strength in our core brands. That will continue to drive our total profit as our margins are very sustainable.

Just a follow-up on that, if you look at historically, the legacy Dr Pepper portfolio versus your competition in North America, that portfolio outperformed on an operating profit basis, right? And now, obviously, expectations for both Coke and Pepsi are much higher. Is that performance gap you expect to continue, like legacy Dr Pepper portfolio should still be outperforming those two companies in terms of the North American performance, right?

Well, we did spend a lot of time thinking about our performance relative and operating profit relative to our peers. We look at our business. We look at the upside that we have. We see a lot of upside on our business in absolute terms. As I point out to many people, our portfolio in many cases is not in direct competition with Coke or Pepsi, particularly on the CSD side, where our strength is in the non-cola segment with Dr Pepper and Canada Dry leading the way. So I don’t think that has changed at all. And look, to answer your question, all of our upside that we believe is in the business in total is reflected in the long-term targets that we set forth.

Two questions, I mean, the first one on McCafé. Kraft Heinz indicated that McCafé would hit the EBITDA by about $200 million in over 12 months. Should we think, I mean you will gain that $200 million in your EBITDA from mid-next year to mid-21? And could you tell us what is your plan for that brand that we will carry?

Yes. First of all, the way that we will look at this move of McCafé into the Keurig system really speaks to the value of the Keurig system. It's a vote of confidence. And I will remind everybody that if you look at all of our branded partners, most of them, but nearly all of them at this point in time as the contracts have expired, have extended for longer periods of time than they ever have before. So, there is just one more vote of confidence that partnering with Keurig is good for everybody in the ecosystem. We transition that over to us in 2020. There are upfront investments that are involved with it. We will talk when we talk about 2020 and how that impacts our guidance then. But remember to take the puts and takes together, we don’t know what the environment is going to be in 2020. That would be a negative, so we got positives and negatives, and as I said before, it's our job to navigate all of those and be able to deliver the long-term guidance. I have not seen the number that you are referring to; all I would suggest though is there is about $300 million in retail sales, not wholesale, and I could not give a number merely that big based on a retail business of $300 million if you haven’t seen that one; but we’ll provide more clarity when we talk about 2020 and how that may impact our results at that time.

Let me just remind you, it's Maria, is that we already had McCafé in the system. So, as you think about incrementality and what it might mean to the business, it was already in. This is a different relationship. It's broader, as I’m sure you know. But it's not wholly incremental, and I think that’s important to keep in mind.

Yes, that’s a good point. Just to, thank you for bringing that up. I think to put a final thought on that one is, we already participated in the financials of McCafé to a level through the K-Cup business that we have. So, it's not unlicensed business that came in, but that this is all incredibly positive for us. We just don’t - I think the number you put out there would be very big and it’s not necessarily incremental, and so that’s what we’re clarifying.

And a quick one again on the concentrate business. Obviously, so profitable for you, so there are some implications about the next quarter and the future. So, either, I mean you're volume and you're sales, and volumes were very strong in the quarter. Could you tell us the level of inventory at labor? And it seems there is a disconnecting performance versus what we are seeing in the Nielsen data?

Well, I don’t know how you could see that data, to be honest with you. A lot of this goes through restaurants and places that are different to really to all I suggest that this quarter does not disconnect between our sales and what we believe is consumption out there at all. But we've been really candid on K-Cup when we ship ahead of the consumption and calling that out. So, we feel the first one to call that out, this is reflective, as I said before, of a couple of things. You've got really good volume dollars; our business is very healthy across those channels, and we specifically called out Fountain Foodservice, where our brands continue to be in great demand. This is reflective also of pricing that was put in place and, as always, the delay on pricing flowing through. When you have a combination of pricing starting to flow through combined with volume, that holds up in the base of that, yes, you’re going to see some very good numbers and there is a little bit of what was exactly this quarter a year ago, but something is extraordinary in that number that should cause concern.

Bob, I appreciate the color on the tracked versus untracked performance in pods. Is there anything you can share in terms of the price versus volume relationship, kind of where the untracked channel versus what we see in the track? And then the second part, while we are on the coffee business, I appreciate the color on the Q4 pod volume, but brewer volume cycling a very easy comparison. How are you thinking about brewer shipment volume next quarter?

Yes. So, I’ll start with the brewer shipment volume, and again, we minimize the impact of brewer volume. Our objective is to grow household penetration, and I think we have some credibility on that. We had some conversation when there was a quarter ago, which you refer to as an easy comparison that caused a lot of concern, and we’re way ahead since then. I mean we’re running like a 12.5% growth since that time period. You haven’t heard us for a second refer to that number nor do we use that as a predictor of household penetration because we don’t believe it's a predictor of household penetration. So, I would suggest that the fourth quarter of this year, again, household penetration based on the volume that you’re seeing is growing mid-single digits. You’re seeing brewer growth so far year-to-date above 10% that would suggest that we shipped brewers for the holidays earlier than we have, and that’s part of the strategy for our customers. So I think that back to my comments I made on pods reverting to the mean; I think it's the same role that applies on brewers. Over time, it’s a very steady number. The fact that we shipped some earlier is net a good thing because it means we forward position the product for merchandising during the holiday season. But in the end, we think it has very little to do as an indicator of performance for our pod business whether it's up or down. We don’t spend a lot of time talking about that for that reason. Having said that, let me talk about pod as you refer to, it's getting increasingly difficult for you guys to track this business using IRi or Nielsen because tracked channels are now representing about 50% of our total sales. And the untracked channels, which are driven by club and e-commerce, particularly, and other channels, are in total growing faster than the tracked channel. That separation is accelerating, as you can imagine, with the adoption of e-commerce. We believe our e-commerce business is 2x to 3x the size of a typical CPG business. So, the trend that you're seeing with us is really the leading-edge of where you're going to see the rest of CPG go over time. When we take a look at our business in the untracked channels, its growing faster, but if you ask about the composition of volume and mix, it is not materially different than what you see in tracked channels. Our PDP manufactured share and our owned and licensed share, we believe when we look at our untracked channel is slightly higher than it is in the track channels, like for example away from home. Offices are in here, and our share in offices of our own brand is higher, but it is not material enough for you to put too much thought in there. It's just the knowledge that you are only looking at half the market. Unfortunately for modeling purposes, the other after market is not transparent to you and growing at a faster rate, which we continue to see accelerating. It's good for the business. In total, it's just harder to observe from the outside.

Thanks everyone for joining the call today, and I know we went a little bit over, and it’s a busy day for everyone, but the IR team is around today for any follow-up questions. Thank you.