Q2 2019 Earnings Call
Good morning, ladies and gentlemen, and thank you for standing by.
Welcome to curate Dr. Pepper's, earning call for the second quarter of 2019.
This conference is being recorded and there will be a question and answer session at the end of the call I would now like to introduce your host for today's conference Curis, Dr. Pepper, Vice President of Investor Relations.
Mr. Tyson Sealy Mr. Ceilings. Please go ahead.
Thank you and Hello, everyone. Thanks for joining us.
Earlier. This morning, we issued our press release for the second quarter of 2019, if you need a copy you can get one on our website at curing Dr. Pepper Dot com in the Investor section.
Consistent with previous quarters today, we will be discussing our results our performance on an adjusted basis, excluding items affecting comparability and with GARP in 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 in an appropriate basis for discussion of our performance.
Detailed on the excluded items are included in the reconciliation tables included 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 reconciled our guidance here with me to discuss our second quarter 2019 results and our outlook for the balance of the year or KDP, Chairman and CEO , Bob Gamgort, our CFO <unk> CFO Ozon Doc messy Oakley in 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 the risks and uncertainties is contained in the companys filings with the SEC with that I'll hand, it over to Bob.
Thanks, Tyson and thanks to everyone for dialing in.
The second quarter was another good one for KDP all four of our segments again registered underlying net sales growth with coffee systems, leading the performance this quarter.
We also had new dollar consumption and held or grew market share in a number of our key categories.
A recent slate of innovation is performing well in the market and we remain confident in our plants in this area for the balance of the year, which I will talk about shortly.
Operating income advanced nearly 10% despite a more than three percentage point headwind related to the comparison against the gain recorded in Q2 last year in connection with the Big Red acquisition, and a onetime reimbursement from resin supplier.
The significant operating income growth combined with lower interest expense versus the year ago period drove a 15% increase in adjusted diluted EPS for the quarter, which is right in line with our long term targets.
Free cash flow generation of $575 million for the quarter was also robust.
Which enabled us to repay debt of more than $300 million in the quarter and nearly $720 million in the first half of the year.
The quarter marks a significant milestone for us as it closes our first 12 month as a combined company.
Before we jump into the details of the latest quarter. We believe it's helpful to recap what KDP has delivered in its first year as a public company.
From a financial results perspective at the time of the acquisition announcement, we targeted a three year average adjusted diluted EPS growth rate of 15% to 17%.
Fueled by top line growth of 2% to 3% combined with expansion in margin, resulting from $600 million and acquisition synergies and ongoing productivity programs.
We delivered well above the high end of our expectations in year one.
With 12 month, adjusted diluted EPS growth of nearly 30%.
And operating margins expanding by 250 points.
As we delivered synergies at the pace, we committed to last year.
Debt reduction is also an important part of our value creation story, and we are well on track to reach our target of reducing leverage to below three acts by July of 2021.
Having paid down approximately $1.65 billion worth of debt.
And returning over $860 million in dividends to our shareholders and our first 12 months.
Additional year, one achievements include growing retail dollar consumption and gaining or maintaining market share in the majority of the categories in which we compete.
Signing eight new allies in partner agreements acquiring the core hydration and big Red businesses.
And strengthening our innovation pipeline.
Launching seven new cured Brewers and over a dozen brand extensions across our coal portfolio.
Breaking ground on a state of the art Teacup manufacturing facility in Spartanburg South Carolina.
Where we remain on track to begin production in late 2020.
Launching our drink well do good corporate responsibility platform and commitments.
Leveraging our expanded operations broaden community presence and combined resources to make an even greater positive impact for our stakeholders.
And most importantly, uniting 25000 employees under a common mission to become the new challenger in the beverage industry.
By being the first company to bring hot and cold beverages together at scale.
In that respect we believe we're just getting started towards realizing our full potential.
With that your one context in mind, you'll note that the second quarter of 2019 was a continuation of our strong value creation story.
I'll start with in market results based on IRI.
Retail market performance was solid in the quarter.
We grew or held market share the key categories of Csds.
Single serve coffee premium Unflavored, Stillwater shelf stable fruit drinks and ready to drink coffee among others.
This performance reflected the growth of key brands, such as Dr. Pepper in Canada dry csds.
Core hydration pizza and four to ready to drink coffees and snapple juice drinks.
And are you at a coffee business retail consumption of single serve pod manufactured by KDP grew approximately 5%.
And our KDP manufactured dollar market share was essentially even with the year ago at 81.6%.
Turning now to the financials on an adjusted basis.
Our underlying net sales, which exclude the movement in and out of Allied brands grew 2.6% due to volume and mix growth.
And higher net price realization.
In addition, we also had a modest benefit from the shift of Easter into the second quarter of this year.
Offsetting this growth was the expected unfavorable impact in our packaged beverages segment from the changes in our allied brands portfolio.
Specifically on a year over year basis, the net change in our Allied brands portfolio reflected Evian, Pete and fourth continuing to ramp up.
As compared to the established BG and body Arbor businesses last year that have since exited.
In thinking about the balance of the year you should expect this headwind to abate in the last quarter of 2019.
Adjusted operating income grew nearly 10% for 230 basis points to 25% of net sales.
Primarily reflecting strong productivity in merger synergies both of which benefited our cost of goods sold and ESG today.
These positive drivers more than offset inflation, particularly in packaging and logistics as well as the unfavorable comparison versus the year ago period.
Which included the previously mentioned one time benefits totaling $21 million in connection with the big Red acquisition and reimbursement from a resin supplier in the second quarter of 2018.
Adjusted diluted EPS increased 15% to 30 cents in the quarter compared to 26 cents in the prior year period.
Driven by the growth of operating income and lower interest expense.
Turning now to our segments.
Starting with coffee systems, which had a very strong quarter in part due to timing.
Net sales increased 4.3%.
Roughly 13% for K Cup pods and 19% for Brewers.
This growth was due to the underlying strength of the business.
And timing related to some earlier shipments as requested by our branded partners.
Partially offsetting this growth was lower pot shipment mix due to higher timing related sales increased two branded partners for whom we only record a tolling fee.
You'll note that the timing impact of partner shipments drove our total pod shipment volume in the quarter to be above our consumption rate.
On a longer term basis, you should expect our pod shipment volume growth to be in line with category growth, which has been approximating 6%.
The strong brewer volume growth also reflected some benefit of timing related to the retail inventory build for our back to school and the holidays.
As well as the K dual innovation launch and Amazon Prime day.
The latter of which was a record breaking day for us this year.
Specifically the K many had the highest one day volume, but any brewer deal on Amazon.
In the K Cafe had another strong quarter.
Our new K dual lineup of Brewers provide consumers the ability to brew a large product coffee through a traditional drip system.
In addition to a single Cup through K Cup pods.
Early feedback from consumers is very positive and we have confidence that this innovation will continue to bring households that were not that were not previously single serve users into our system.
With K dual essential is now on shelf.
Okay dual and K dual plus shipping later this month.
And our recently introduced CAE Cafe and Kayne, many already in the market and performing well we are supporting these innovations with significant marketing of cost across traditional and digital media platforms starting in Q3.
We're also excited to announce that our marketing campaign features the return of the talented and energetic James Corden as our brand ambassador.
We will continue with our brutal love campaign. This time, putting the spotlight on the new K do a brewer.
Operating income for coffee systems increased more than 8% in the second quarter, reflecting the strong growth in Pos sales and productivity.
One final note on coffee systems, we continue to keep a close eye on the recent news out of Washington regarding additional China tariffs.
Recognizing this is an ever changing landscape. If the current proposal planned for September is enacted coffee systems will face a headwind approximating $10 million to $15 million in the remainder of 2019.
As Q4 is our peak quarter for Brewer shipments and we would have little time remaining in the year to implement steps to offset.
As we've mentioned previously we've already taken actions to diversify our brewer supply base.
And we continue to explore additional opportunities to mitigate the impact that potential tariffs may pose.
All of which would benefit us in 2020.
Turning to the package beverages segment.
Net sales for packaged beverages were again significantly impacted by the expected unfavorable impact from the net changes in our allied brands portfolio.
Which amounted to a 6.3% headwind to the segment in the second quarter.
Excluding this impact as well as the 0.5% benefit we had from the shift of Easter into the second quarter.
Underlying net sales grew 1% in the quarter driven by net price realization of 2%, partially offset by lower volume mix of 1%.
Driving the underlying net sales growth for packaged beverages in the quarter was the continued strength of Dr. Pepper in Canada dry.
Each fueled in part by innovation.
In the second quarter, we launched a limited time offering of Dr. Pepper, Dark Berry, which was released in conjunction with Marvel Studios Spider Man far from home.
In addition, diet, Canada, dry ginger around lemonade, and Canada dry ginger around orangeade, which were launched earlier this year continued to perform well.
Also contributing to the underlying sales growth in the quarter were sunkist and core hydration as well as contract manufacturing.
On the other hand by was soft in the quarter.
We recently regained some distribution that we lost in Q2 last year.
And our increasing in market support.
We expect these actions to improve by performance over the next few quarters.
Operating income for packaged beverages in the second quarter advanced 18%.
Largely reflecting strong productivity and merger synergies as well as higher pricing and the timing of marketing investments.
Partially offset by inflation, particularly in packaging and manufacturing input costs.
Looking ahead to fall in the start of college football. We're excited excited to announce the return of our highly successful fans Ville marketing campaign behind Dr. Pepper.
As you May recall, the fans will campaign had a storyline that evolves over the course of the college football season.
Culminating in the college football Championship.
In addition to TV. The campaign includes digital and social media print advertising in store support and our usual college tuition giveaway program.
The fans feel campaign was very effective last year, and we expect it to resonate with consumers again this year.
Turning now to the beverage concentrate segment, which represents sales of concentrates the bottlers and syrups to fountain customers.
Net sales increased 3.1% driven by net price realization of 4.4%, partially offset by lower volume mix and unfavorable foreign currency translation.
The growth in net sales continued to be fueled by Dr. Pepper as well as increases for Canada, dry schweppes and a and w.
Operating income for the beverage concentrates segment advanced 4.2% in the quarter.
Primarily reflecting the growth in net sale.
And finally, turning to Latin America beverages.
Net sales for the segment increased 3.7% in the second quarter.
Reflecting both higher net price realization and favorable foreign currency translation.
Partially offset by lower volume mix.
Operating income for Latin America beverages of $20 million in the second quarter of 2019 was approximately $6 million below the year ago period period, primarily due to lapping a $5 million benefit related to the reimbursement by a resin supplier in the year ago period, as well as the impact of inflation.
Partially offsetting these drivers were the benefits of net sales growth and continued productivity.
As I discuss upfront the newly combined organization is highly focused and executing well accomplishing a great deal in a short period of time.
We're pleased with how this quarter contributed to our successful year, one while recognizing that we're only just beginning.
And our sights are set on much more.
With that I will turn it over to Jose.
Thanks, Bob and good morning, everyone.
I will start with a review of the financials for the second quarter.
Which was another strong one for KDP.
I will then turn season to our outlook for the balance of the year.
Continuing on an adjusted basis.
Net sales for the second quarter decreased 0.4% to $2.8 billion to $1 billion.
Compared to $2.8 billion to $2 billion in the prior year.
This performance reflected strong underlying net sales growth of.
2.6%.
Driven by higher volume mix of 2.1%.
And favorable net price realization of 0.5%.
The shift of Easter into the second quarter of 2019 also added 0.2% of growth.
More than offsetting this underlying growth and the calendar shift was the expected unfavorable impact of 3% from changes in our allied brands portfolio.
As well as unfavorable foreign currency translational, 0.2% in the quarter.
On a constant currency basis net sales declined 0.2%.
Operating income in the quarter increased approximate the 10% to $702 million.
Compared to $604 million in the prior year.
Excluding the more than three percentage point headwind from the Unico benefits that Bob mentioned earlier.
Operating income up loans more than 13% in quarter two 2019.
The growth in operating income reflected the strong productivity and synergies in both cost of goods sold and SGN a.
These growth drivers were partially offset by inflation.
Led by packaging and largest logistics.
Operating margin up months 230 basis points in the quarter to an even 25%.
In terms of our segment performance for the second quarter.
On an adjusted basis.
Net sales for coffee systems increased 4.3% to $990 million in the quarter.
This is strong performance reflected higher volume mix of 8.3%.
That was partially offset by lower net price realization of 3.5%.
Unfavorable foreign currency translation of 0.5% also impacted the quarter.
On a constant currency basis coffee systems net sales of funds 4.8%.
Operating income for coffee systems up loans, 8.2% to $331 million.
Compared to $306 million in the Payor yet.
Driving this performance were the benefits of the net sales growth.
Some will reach reverses in quarter three.
Due to timing and productivity.
Partially offsetting these factors was inflation in packaging and logistics.
Operating margin up one to 120 basis points in the quarter to further 3.4%.
Moving to packaged beverages.
Net sales for the segment decreased 4.9% in the quarter to one point for the $1 billion compared to one point for the $8 billion in the prior year.
This performance reflected underlying net sales growth of 1% driven by higher net price realization of 2%.
Partially offset by lower volume mix of 1%.
In addition.
The shift of Easter.
Into the second quarter had a favorable impact of 0.5%.
More than offsetting these growth drivers.
Was the expected unfavorable impact from changes in the Allied brands portfolio, let totaled 6.3% in the quarter and unfavorable foreign currency translation of 0.1%.
Operating income for packaged beverages increased 18% to $190 million in the second quarter.
Compared to $161 million in the year ago period.
This performance largely reflected the strong productivity and merger synergies.
As well as the timing of marketing investments.
These positive drivers were partially offset by inflation in packaging and manufacturing input costs.
Operating margin at one 280 basis points versus year ago to 14.5%.
Turning to beverage concentrates.
Net sales for the segment increased 3.1% in the quarter to $370 million.
This performance was driven by higher net price realization of 4.4%.
Partially offset by lower volume mix of 1.1%.
And unfavorable currency translation of 0.2%.
On a constant currency basis.
Beverage concentrates net sales advanced 3.3%.
The net sales growth was driven by Dr Pepper, Canada, dry schweppes and W.
The shipment volume decrease for beverage concentrates was due primarily to Dr Pepper and cash.
Partially offset by higher volume for Canada dry.
In terms of bottler case sales.
Beverage concentrates increase of 1.9% compared to the year ago period.
Operating income for beverage concentrates increased 4.2% to $246 million compared to $236 million in the year ago period.
Reflecting the benefit of the net sales growth.
Operating margin up months 80 basis points versus year ago to 6% to 6.5%.
Turning to Latin America beverages.
Net sales for the segment increased 3.7% to $141 million.
Compared to $136 million in the prior year.
This performance was driven by higher net price realization of 3.8% and favorable foreign currency translation of 1.3%.
Partially offset by lower volume mix of 1.4%.
Operating income for Latin America beverages totaled $20 million in the second quarter.
Compared to $26 million in the year ago period.
This performance reflected the unfavorable impact of Comping, the $5 million benefit in 2018.
That Bob mentioned previously.
As well as inflation in logistics and input costs.
Partially offsetting these factors versus the benefits of the net sales growth and productivity.
Turning to interest expense.
Interest expense in the second quarter declined $37 million to $138 million.
This improvement reflected a $13 million benefit from unwinding several interest rate swap contracts in the quarter.
Combined with the benefit of our continued de leveraging.
Net income for the quarter increased 19% to $423 million compared to $356 million in the prior year.
This performance was driven by the strong operating income growth and lower interest expense, partially offset by a higher effective tax rate.
Taking all of these factors together.
Our adjusted diluted EPS in the quarter increased 15%.
To further sense.
Compared to 26 cents in the prior years.
In terms of leverage.
We paid down $303 million of debt.
In the second quarter.
This increase is the total amount of debt pay down in the first six months of 2019, two $717 million.
In addition at the end of the second quarter, we had $106 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 4.9 times.
This aggressive pace of de leveraging continues to be consistent with our expectations.
For perspective.
Since the merger close we have paid down a total of approximate the $1.6 billion to $5 billion owed debt.
In terms of cash flow, we generated $1.1 billion of free cash flow in the first six months of the years.
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 one point 20 to one point $22 per share.
This guidance is in line with our long term merger target.
We expect net sales growth to approximate 2%, which is also in line with our long term merger target of 2% to 3%.
This net sales guidance includes an approximate 100 basis points headwind impact from the changes in the Allied brands portfolio.
We continue to expect merger synergies of $200 million in 2019.
This is consistent with our long term merger target.
And we continue to expect these synergies to fully flow through to EPS.
We now expect interest expense to be in the range of $550 million to $565 million.
This is this reflects our expectation of significant cash flow generation and continued de leveraging during 2019.
As well as the first health benefit in 2019 totaling $40 million from the unwinding of interest rate swap contracts.
In the second half of 2019.
We are not currently planning to unwind any additional interest rate swap contracts also impacting the expected interest expense in the year is the exclusion from our adjusted results of non cash amortization of the fair value adjustment related to the merger on a portion of our debt.
In finalizing our measurement period associated with the merger. We made this change to recognize this as an item affecting comparability to be consistent with the manner in which we treat amortization of intangibles.
The effect of this reduces full year 2019, adjusted pro forma interest expense by $26 million.
And 2018 interest expense by $22 million, having virtually no impact on our overall year over year results.
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 shares outstanding to approach one point for the 2 billion in 2019.
While we are not providing EPS guidance by quarter.
We continue to expect EPS growth versus 2018 to be tempered in quarter three.
Due to Comping the significant onetime gains recorded in the prior year.
Totaling approximately $30 million related to previously disclosed gains on allied brands.
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.
And finally in 2019, we continue to expect free cash flow to approximate $2.3 billion to $2.5 billion.
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 within three years from merger closing.
And with that I will hand, it back to the operator to open it up for questions.
As a reminder, if you would like to ask a question. Please press star one on your telephone keypad again Thats Star one if you would like to ask a question.
Your first question comes from Bryan Spillane of Bank of America.
Hey, good morning, everyone Hi, Brian .
So Bob maybe just a couple of follow up questions related to the to the coffee business. One day, if I caught it right. It sounds like that the category growing posit sex and you're growing at five so if you can kind of talk about that that gap.
And then second.
I guess given that the category growth and how we should think about that in terms of.
Household penetration for for Brewers.
Yes.
We talk a lot about quarter to quarter month to month I think.
This business is actually very stable and very predictable.
And I say stable stable at the growth rate, we've all talked about which is mid single digit. So if I just step back for a second talking about the last 12 months and I'll address your specific question you look at over the past 12 months, we said at the end of the year when we give our once a year omnibus.
Research that household penetration was growing at 7%.
If you take a look at the pod category growth based on IR I over the past year was growing at 6.2%.
And if you look at our shipments over that same time, it's 7.7%. So all of this triangulate around a growth of 6% to 7% and in any given quarter, we're going to be above we're going to be behind but it's pretty remarkable how much the household penetration in the category and our shipments all track to the same number.
Which has been 7% over the past 12 months. The one piece, it's interesting and we're exploring ways to help you guys get more visibility of this is that we're seeing IR III is now consistently under reporting.
Both our consumption as well as the category consumption and Thats because in this category probably more than any other food and beverage category.
On measured channels, driven by our driven by E. Commerce for example.
Our accelerating and taking a bigger chunk of the total pie. So we're thinking about how we can get you guys exposure to that but we know that IRA is understating, our consumption as well as the category. So I step back and say, we said household penetration growing 7.7% our potash shipments have been 7.7 over the past 12 months, that's all within the right.
Range that you should think about and therefore the go right back to your question a plus six versus a plus five is within the margin of error that it almost doesn't matter.
Okay, great. Thank you sure.
Your next question comes from Lauren Lieberman of Barclays.
Great. Thanks, good morning.
Hi, Ron.
And I was hoping you could just talk a little bit.
About.
New partnerships.
Owned or partnerships in particular in the energy space. So.
New agreements for arena in for a shock to the minority investor in Asia, So talk a little bit about kind of portfolio strategy with those brands how they fit in.
Any kind of early read the guest room has been under your purview in the market for most of the quarter. So anything there would be helpful.
I think it's very early days for both.
So there's not a lot to comment on there I would think by the next quarter, we'll have more to talk about what the strategy here behind energy is one that I think speaks to our our desire to fill in white space in our portfolio.
In energy is a attractive category both in terms of size growth and profitability and we certainly should close some of that gap as well as it speaks to the way that we go about addressing those gaps and I think the shock example is a really interesting wanted because we're partnering with.
Lance Collins, who develop core infuse at NASS and a bunch of other products as well that have been very successful and we went into this one side by side with him based on the concept.
With the Prenegotiated formula to buy it out at certain milestones. So it's very early days.
It's only in filing for markets, La Texas, Illinois, right now and we'll see how that goes and give you an update next time around but were bullish on the opportunity there and I think more importantly, it gives you an indication of where we want to go with partnerships.
Great. Thanks.
Okay. Thank you.
Your next question comes from Judy Hong of Goldman Sachs.
Thank you good morning, our Judy.
So I had a question about your sales guidance, so when I kind of look at the first.
Half or second quarter. It looks like sales actually came in a bit short of I think what most people had expected even with the timing benefit on the coffee sales so.
I know, you're keeping the 2% for the full year, which does imply a pretty big acceleration in the back half. So my questions are one with second quarter in line with your expectations from a sales perspective, and then can you just walk us through how we get to.
You know sort of 2% for the full year, which.
I think implies the allied brands kind of impact actually turning to be a tailwind in the second half the year. So that seems also like a big step up as well. So if you can kind of address.
Those issues as it relates to sales guidance. Thank you.
I think it's a couple of things I think first of all just with a conversation with guidance from an overall perspective back in January of 18, we talked about.
Our long term outlook, where we said 2% to 3%.
Over a three year period, 15% to 17% EPS over a three year period, and so we've just stuck to that.
And as you know we have a have to navigate a lot of different changes in the marketplace, but.
We feel confident that we will stick to that framework and we'll stick to it over the long term unless there's some big change to take it.
A different direction, which we don't foresee so having said that.
I think the hardest part for.
You guys on the outside to model has been the impact of this allied brands and all I would say is it impacts us through Q1 through Q3 and then in Q4 this year it goes away.
And there's really you're getting an even comparison and I will be very happy to not talk about underlying net sales at that point and just talk about reported net sales at that point in time, and so I think thats part of it as well so it's a combination of the two the other part is we also said that we would be ramping up.
The growth over time because.
Security business, we were still into the strategic pricing implementation and so that 2% to 3% again as a long term target.
And Thats why we take a look at that the at the year the way that we described it.
But on the Allied brands impact am I right in thinking so year to date I think the impact was a negative 160 million or so and you're guiding to $110 million negative for the full year. So this third quarter is a negative it sounds like the fourth quarter you all of sudden have a pretty meaningful acceleration.
Well remember when you get when you get to the fourth quarter.
The comparison against very substantial businesses of Fiji and body armor are now out of your base.
And you have the benefit of our growing Evian pizza at Forteo in the in the business for this year. So you would expect fourth quarter to materially different than we've seen in the first three quarters of the year and I think thats been the hardest part to model.
Got it okay. Thank you okay.
Your next question comes from Amit Sharma of BMO capital.
Hi, good morning, everyone.
Good morning.
Okay, and just a quick clarification can you quantify the margin impact of the ship in the coffee system business in the quarter.
I mean.
We are not going to get into the specifics of that but the as part of the quarter to growth will reverse in Q3 due to timing of the retailers stocking approvals and the timing of the port shipments to our partners as they requested.
But as Bob explained I believe in a great detail.
It's one would expect to see 6% to 7% of cost growth on a continued basis some car to some quarters, maybe a little bit plus or minus but that's what outages on an annual basis Valley sold on the base of that.
There will be some correction that we are expecting in Q3.
But the.
For the moment and not to expect on an annual basis, our guidance is to hold switches at mid single digit growth.
Got it and then Bob.
Just want to make sure that I heard this right. So as you are talking about strategic price implementation.
Are you, suggesting that we start to lap the impact of that later this year or certainly in 2020, and if that happens like.
Does that mean, the price mix becomes less of a headwind in 2020 and beyond that.
Now I will go back to what we said in January of 18, because it's it's playing out exactly as we discussed we said that volume would be mid single digits the strategic pricing.
Investment would continue for a period of time, but would moderate over the over the horizon that we put out there for our target.
And and again, that's exactly what's happening a 7% household penetration over the past 12 months, 7.7% shipment growth I think what's interesting is when you take a look at our coffee systems revenue.
In 2018, it was negative 2.4%.
On the latest 12 months, it's positive 1.5% if I just look at year to date 2019, its positive 3%. So we're not seeing anything different than what we said all the way back in 2018, all I would suggest is now 12 months into the at risk official close of the merger essentially 18 months since we communicated the the first outlook, it's playing out exactly as scripted theres no change in our thought process around the coffee systems business.
Okay, That's fair and maybe maybe I didn't speak properly I think that's what I'm, saying that as you go into 2020.
Dad price headwind starts to moderate even more especially as we lap it's already been it's already been moderating.
Continue to moderate over the three year horizon, but we never gave a timing of saying.
Pricing investment would stop on a certain date, we said it would moderate overtime and it and you're seeing the slope of it right now if you go back all the way through January 18, you could you could put the slope out between then and now and see that improvement.
And that's exactly what we expect to continue and again I just want make one other point on this.
We we have visibility internally as to what the pricing is going to be because these are based on long term contracts for the great majority of our agreement and so I know, it's a challenge for you to model, but it's not a challenge for us to manage because we see it and we also know that we have the appropriate productivity.
And costs.
Projects in place to offset that pricing and the evidence that youve seen is that we've been able to handle this pricing investment at the same time, we're expanding margin and accelerating volume growth. So it's not a big mystery to us its effective not a mystery at all we have it mapped out it's just a challenge for us to get out and communicate.
Too many details to the outside world here, but just know that internally, we have good visibility of it.
Got it thank you so much more.
Your next question comes from Kevin Grundy of Jefferies.
Hey, good morning, everyone. Good morning.
Hey, Bob can you speak to the pressure on the buy business. This was of course, a sizable acquisition from the Allied portfolio a few years ago.
So.
Disappointing performing well below expectations at this point can you talk about some of the factors driving the weakness competitive dynamics lack of investment lack of innovation.
Maybe just drill down a bit more on your plans to turn that brand around thanks.
Yes sure. Thanks, Bye is now north of $400 million in sales.
And on a 52 week basis, its grown about 6%.
Was a weak quarter, we lost some distribution along the way we've since regained that but you're seeing it go through the system and so as I said, we expected to improve in the coming quarters.
Brand still has a lot of legs to it there are elements of by for example by Super teeth are growing at an incredibly good rate. The core business is reasonably healthy by bubbles hasn't been as strong. So if you really drill into it the core by business is quite strong.
And some of the newer additions to the buy portfolio or adding evening, even further growth, but this was we analyze these things.
Very extensively and this was all driven by some could buy some distribution changes not velocity changes in the business and so we're still bullish on the brand going forward.
And as I said number 10 for.
When you get to a certain scale, what crossing $400 million approaching $500 million in sales youre not going to see 20, 30% growth rates. It's just the natural evolution of all of these brands, where when it was acquired it within the steep part of the growth curve continue to do really well now it's going to be more in a moderate growth curve going forward.
But none of us are happy with a negative even for a quarter or so so thats that quickly being addressed.
Thanks, Bob I'll pass it on thank you okay.
Your next question comes from Steve powers of Deutsche Bank.
Hey, guys. Thanks, good morning.
Good morning.
I guess one follow up question to Brian's initial one 6% you cited for the category consumption. This quarter is it just to be clear is that all channel number just because it looks like the measured channels at least as I see it the Nielsen data it looks like it was tracking five plus alone.
So unexpected maybe closer to seven if the contract was as strong as we talked about before just final clarity there would be great for the go ahead, yes, no closer and then is that my real question was just more on the the negative part mix that we saw this quarter directionally.
Not really a surprise, but I just wonder if you're able to quantify the magnitude because it was bigger this quarter with a with a with a timing element.
But and then stepping back I guess really what I'm asking about is how should we how do you recommend we think about.
Pod mix going forward to the extent that we should expect that to remain a bit of a structural headwind on revenue growth.
Even as pricing, maybe get a little bit better.
Okay. Let me, let me start with the last one and I'll come back to the category piece I agree.
The best way for you guys to take a look at this is.
Go back to how I started this is look at it over a 12 month basis and know that what we've said about the coffee category over a 12 month basis has come a 100% true in terms of what our projections have been.
There is variation quarter to quarter and so the key is when you see variation by quarter is a good assumption is that it goes back to the average again overtime and so I I can explain the mix very easily in the second quarter.
The shipments above consumption was all driven by certain partners requesting more volume early that we could be in advance of a promotion it could be because they are doing some internal changes to their own warehousing or supply chain and they want to make some movements built some inventory. This is for us normal course of business quarter to quarter or month to month.
And it all flattens out overtime.
Because this situation was accelerated shipments from our traditional branded partners you will recall in that situation, we receive a tolling fee.
On the on those products versus a complete product fee. For example, if we supply a private label partner, we source the coffee, we do everything and we charge them a full product price in the case of branded partners, where we received the coffee from them. We're just charging a tolling fee so by its very nature.
It's going to show up as a negative mix if you sell more of that volume versus all other volume. It's just mechanical and has no impact on the business at all from a profitability standpoint in order that impacted business overtime. So my suggestion as you think about.
What will be the third quarter in the fourth quarter Pos growth.
You have to make some adjustments to say, we've now shipped in advance of consumption and were being completely transparent with you on that that's got to come out at some point that's not that doesn't.
Go up forever, but the mix also normalize as well because that was specifically due to partner shipping in advance and there is no structural change to our business at all from a mix perspective.
So let me move now to the category piece the exact category number and this is all channels that can be measured by IRS bye.
On a 52 week basis, it was 6.2% interestingly for KDP. It was 6.2%, which means we help KDP manufactured share.
Exactly even over the 52 week for the second quarter, We said, 6%. The exact number was 5.6% for the category, what we're saying though is.
There are channels club.
Department stores.
Away from home, but E. Commerce is the biggest one right now that are not captured at all by even an IR right all channels metric.
And those are more significant than a typical CPG product and growing faster.
Then.
Then, which you can see in the measured channels and that's where you get the point about over a 52 week basis. It suggests that our consumption growth was 6.2% and yet over that same time period, we shipped 7.7%.
Our perspective is that's not us over shipping a category, that's reflecting what's actually happening in the on measured channels and again.
We have empathy for the factor you are trying to build models that don't have access to the data that we do we are trying to think about a orderly way in which we can give you insight into what the on measured channels are and I imagine we're kind of a pioneer on this but this is an issue you are going to face in a lot of categories as ecommerce becomes more significant I. Just think we're further ahead of the curve. So hopefully that answers. Your two questions. Let me know if you have any any more clarification needed on it that's perfect. Thanks, so much okay.
Your next question comes from Laurent Grandet of Guggenheim Securities.
Hi, Ross good morning, Amazon for later on.
Oh, Okay. Good morning.
Morning.
For you just on the Dr Pepper franchise.
It continues to perform really well.
And it's not just driving the top line I think it's contributing quite a bit to the margin expansion that you're getting.
Can you just talk about how you see that playing out over the course of the year and then longer term.
Kind of the same just.
What do you see are the strengths of that brand and what's what's going to help us continue to do what it's doing yes, it's a it's a.
Having been in the CPG industry for very long time, you see certain brands that is real jams and this is one of them. It's got very unique positioning unique product offering. It is one of those brands that the.
Heavy consumers of it absolutely love.
And it continues to expand household penetration it used to be at one time, a very regional brand is now national brand and so if you take a look at the brand development, there's still opportunity to increase household penetration.
In the regions of the country, where it was less established.
This is a good story of getting everything right in terms of marketing strength.
Limited edition innovation.
And great execution, and I would remind you that part of the reason why the profitability shows up is even stronger on this brand.
It is because the way it flows through our PNM now is a is a more than half of that business is distributed through coke and Pepsi system in which we sell concentrate to them in the concentrate shows up on the PML as a much higher margin mix and therefore, when you grow the Dr. Pepper brand a big chunk of that goes through that very profitable.
Coke and Pepsi system that shows up as a real profit generator on the TNL. So.
We have no weve everything that we take a look on Dr. Pepper brand has continued strong performance on that there is still a lot of upside on that front.
Your next question comes from Bonnie Herzog of Wells Fargo.
Thank you good morning, Hi, Bonnie.
Hi, I actually wanted to circle back on your operating margin growth, which was really impressive this quarter. So.
Hoping you guys could maybe break out the contribution from synergies just a bit more in depth and then looking forward should we expect a meaningful ramp in the contribution from these cost synergies as you get maybe even deeper into the integration process. Thanks.
Yes.
First of all as Viavi todays it many times and we are on that trajectory in terms of delivering $28 million of merger synergies.
In 2019, 2020, 2020, and 20 to 21 in total six on that meeting goals. So we are confirming that trajectory as well as for this year.
And as we also said besides the deal synergies.
You also have as we define base productivities and as we spoke.
Probably 10 15 minutes ago, we expect.
Both deal synergies and the base productivity is to continue to ramp up as we go throughout 2000.
19, which means the second half.
We expect to deliver overall productivity is illegal higher embedded number compared to the first half.
So when we look to the margin expansion you are right. Its a very good number but please bear in mind. When do you go back and look to January 2018, the guidance that we put that did foresee a healthy margin expansion and we are happy to share with all of you that fee exacted delivering what we said we would and if we do expect further margin expansion.
To happen again in line with our guidance nor surprise in the upcoming let's say a two more years after 2019 and the balance is quite healthy and between the legacy K GM and they got Cdps businesses, which reflects as a good combined.
Company margin growth and we are exactly on our trajectory in terms of what we said we would do.
Okay. Thank you.
Your next question comes from Robert Stein of Evercore.
Hi, Good morning, it's Brendan Metrano for Robert.
Good morning, Bob Martin Hi, Good morning, Bob just wanted to circle back on packaged beverages for a couple of points first can you give us some insight into.
And how.
The the new Allied brands like maybe on it for two.
Progressing that give you gives you confidence that those those will ramp up and sort of replace.
The brands that you've lost.
And then secondly, any impact from from weather in April and May that you'd kind of call out as an ordinary this this quarter.
Last one I'll go first as a no no meaningful impact from weather on the Allied brands it'll take time, I mean, where you take a look and we were starting from a much smaller base than the two businesses. They came out of the system. That's really clear if you take a look at the you know how big they were versus where we are starting but they are all moving in the right direction and over time the growth trajectory. There. They are wrong plus additional brands that were at will more than offset that.
But the way that we forecasted it is weve been conservative and not assuming that they are a replacement for example, starting in 2020, but it's going to take some time to build on that but one thing I would add though is if you take a look at brands that we've added into our portfolio from an own standpoint.
There are no longer show up and Allied brands core being a great example, core is quite remarkable story now $250 million in sales and it's growing north of 40% now like five my previous conversation by there will be a point, which it hits critical scale is not going to be growing at that trajectory, but to have been able to add a business that was once in allied into our portfolio that that meaningful in size with that kind of growth rate is another way that we are able to manage the portfolio growth in that 2% to 3% long term range that we talked about previously.
And then one real quick follow up just in terms of in the in that Allied.
Portfolio and just you know within packaged beverages Howard how are you and are you I guess thinking about CBD at all.
Well, it's because the basics on CBD are it has to be legal first proven to be safe and proven to be effective and.
All three of those are either no or a question Mark at this point in time.
My My theory on this one is that if it has proven to be safe legal ineffective and the government gives it the greenlight.
And all the other issues that are surrounding it pop up in it in effect becomes caffeine.
And it becomes something that is can be added to a lot of different beverages and if it gets to that point, we will participate in it but we're we're not going to be on the bleeding edge of something that is frowned upon by the government and onshore from a consumer safety standpoint.
Thank you.
Sure.
Your next question comes from Bill Chappell of Suntrust.
Thanks, Good morning.
Good morning Bill.
Hey, Bob as we go into the holiday season, and though its still only August but.
What's the plan the thought for Brewers in terms of you rolled up several last year. The goal was to kind of increase household penetration didn't know if you really need that many more or if it's better if your money is better used on kind of supporting.
Pods or sporting brands or how you look at it as we go into kind of the next year.
Yep household penetration is the growth engine for the entire business when household penetration grows it benefits all parties, who are involved in it the partners, who do business with us the retailers, who sell our machines enterprise as well as whom we supply their branded pod.
And of course, it benefits our own than license business. So if you can pick one metric to drive.
Across the entire coffee system business that would get would benefit everybody, including our our specific TNL. It would clearly be household penetration growth.
The way that we think about Brewers is not how many brewers do we want to sell or how many do we need we think about barriers to household penetration and we talked before about the work that we've done to understand all of the people who should be in the curing system.
And why they're not in there right now and if you step back and think over the past two years, we've increased the number of households, who have a cured machine by 20%.
So that's a that's a meaningful accomplishment in itself yet at 22%, we think that number should be as we said before more than double that and then the question would be how long is it going to take and we don't know we're moving along at a nice 7% rate and the question is could we accelerate that overtime.
The reason the K dual becomes important is because it fills a gap in the need states for Brewers that we know a fairly sizable segment of the non curie households need which is I'm intrigued with the idea of brewing One cup at a time and would probably do it during the week.
But I want the ability to make a pot of coffee on weekends or one company comes over and so therefore, you introduce we introduced the duo specifically to address that group and that's very similar to what we've done in the past with the K, many which targets a specific demographic and price point with the K Cafe, which goes towards people who are interested in specialty coffee cappuccino and latte. So are just to go back. Our goal is to increase household penetration Brewers are the vehicle to do so and the way that we think about innovation in Brewers is to address people who are not in the system, who we want to have come into the system and that's why it makes sense to invest a disproportion amount of marketing and driving household penetration.
Got it and then on the pod manufacturing efficiency.
Should we look at this quarter, where where margins arent moving quite as much as.
Some of the low hanging fruit is starting to to has been picked and maybe any update I think theres, a south Carolina plant the soon to be up and running and will that have meaningful benefits anytime soon.
No. What we know is if you just again I would suggest you take a look at our margin and our progress over time, because it's not evenly distributed quarter by quarter and I think one of the things that we've all learned in the past year is.
We never want to overreact to the positive or the negative of any quarterly numbers I would recall the conversation we had about brewer sales for unit sales back in the fourth quarter of 2018 that scared everybody off.
And we said don't worry about it similarly when were up double digits. We also say, it's not a meaningful metric. So I would suggest that there's really no incremental news on margin at all based on this quarter that it's part of the long term trend.
The point that I made a couple of times is we know that there's pricing investment we talked about it we've been incredibly transparent we have great visibility of it going forward because we have long term contracts with the great majority of our partners.
But we also know that we have a reservoir of productivity and projects to offset that pricing. So we would not have negotiated the deals that we did if we didnt have the ability to to address them through productivity and one of those projects.
Is the state of the art manufacturing facility in South Carolina, and that'll be up sometime in the next year or so, but that's just part of that project and getting towards that goal I don't see anything that that it was.
Exactly.
Venue to again go back and look to the guidance that we put out that actually almost a little bit more than 18 months ago, we set on a coffee standalone basis, including 18.
Through 2021, we expect margins to improve 600 to 700 basis points and as you know we improved almost 300 basis points off of our margins in coffee systems in 2018, and you see the improvement as we have announced in the first two quarters of you today 2019, and we are doing pretty well I must say so you would expect to see further margin improvement again in line with our guidance between now and the end of 20 to 21 and I think all this things as Bob said have been pointing out and still pointing out the great visibility we have the relationship between the topline which relates to the pricing and the strategic moderating off that along a huge visibility and the good great roadmap in terms of improving about base for the activities within the cost of goods sold as overheads and that's what we have been executing and Thats. What we will continue to execute and as Bob said, we have too. Many projects is spot on book is very important last guy on the block, but its one of them and and we just continue to.
To execute.
Great. Thank you.
Okay. Thanks.
This concludes the Q and a portion of todays call I'd like to turn it back over to management for any closing remarks.
Thanks, everyone for dialing in today and joining us I know, we went a little bit over the IR team is around today for any additional follow ups and we look for to tax deal. Thank you.
This concludes today's conference call you may now disconnect.