Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

Dr Pepper Snapple Group, Inc. (NYSE:DPS)

Q2 2008 Earnings Call

August 13, 2008 11:00 am ET

Executives

Aly Noormohamed - Senior Vice President, Investor Relations

Larry D. Young - President, Chief Executive Officer, Director

John O. Stewart - Chief Financial Officer, Executive Vice President, Director

Analysts

Jonathan Feeney - Wachovia Capital Markets LLC

Judy Hong - Goldman Sachs

Kaumil Gajrawala - UBS

Damian Witkowski - Gabelli & Company

Bryan Spillane - Bank of America

[Pria Oregupta] - Lehman Brothers

Operator

Welcome to Dr Pepper Snapple Group’s second quarter 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce Aly Noormohamed, Senior Vice President of Investor Relations.

Aly Noormohamed

Before we begin I’d like to remind you that this call contains forward-looking statements and includes statements concerning our future financial performance which should be considered in connection with the cautionary statements and disclaimers contained in this morning’s earnings press release and our SEC reports. During this call we may reference certain non-GAAP financial measures which we believe provide useful information for investors. Reconciliations of those non-GAAP measures to GAAP can be found in our earnings press release and on the Investor Relations page at www.drpeppersnapple.com.

This morning’s prepared remarks will be made by Larry Young, Dr Pepper Snapple Group’s President and CEO, and John Stewart, our CFO. Following our prepared remarks we will open the call for your questions. With that let me turn the call over to Larry.

Larry D. Young

Before John and I take you through our results for the quarter, I’d like to share a few thoughts about the environment we are operating in today. It’s clearly not the best time to be launching a new company. However my 30+ years of experience in the beverage industry tells me that these challenges are not new. They may be a little more pronounced but I’m fortunate to be surrounded by a team that has not only survived such challenges but has actually used them to thrive, become stronger, leaner and more nimble. We find new opportunities every day but more importantly we stand ready to take advantage of them.

At DPS we’re focused on building the business one bottle at a time and believe our strong flavor portfolio, customer partnerships, and vertically integrated business model will allow us to expand our distribution footprint and bring more of our products to more consumers in more outlets every day as I look at how our B trends colas and waters are being hit hard. Fortunately for DPS these are two areas where we have limited participation. Another soft spot is cold drink. As a lot of you heard me say, availability and cold drink are huge opportunities for Dr Pepper Snapple. With 200,000 pieces of equipment, we are a fraction of the $3+ million assets that are out there. So even though the base may be contracting we still have significant room to grow.

Our second quarter marked the official separation of our business from Cadbury. With that came the need to put in place processes and the reporting necessary to support a stand-alone business. Our new corporate team has stepped up to the plate and has done a magnificent job of establishing our stand-alone financial statements. There’s still much to be done in this area but I’m very pleased with the progress we’ve made in such a short time.

A tough environment. Tough overlaps and necessary pricing result in bottler case sales being down 4% in the quarter. Our North American volume was down 3% and while I can say that down 3% is not a surprise, it’s clearly not where we want it to be as a company. Dr Pepper was down 1% with growth in fountain food service being offset by declines in bottle and can.

Our Snapple business was down 6% as it overlapped 10% growth in the prior year. Promotional events that we ran on our premium line in 2007 were not repeated as they just did not pay out. Additionally, we continue to see unhealthy discounting going on in this category. As I look ahead, I would expect the trends you’re seeing in our Snapple premium line to continue into Q3. At the same time we are confident that the rollout of Snapple Mainstream will offset some of this decline.

7UP volume was down 10% as the brand overlapped the introduction of Diet 7UP and the final stages of the launch support for regular 7UP with 100% natural flavors. 7UP is below our expectations and we are looking at options to restimulate the growth of this great brand.

We continue to be very pleased with the performance in our Mott’s business with volume up 4%. The Mott’s for Tot line continues to be a hit for moms and the multi-serve offering we launched earlier in the year is also helping moms at home. Additionally, we continue to gain new distribution both in juices and in our sauces.

Rounding out the portfolio was Mexico and the Caribbean. We’ve taken significant pricing there to cover commodity costs and combined with an increasingly competitive water segment, volumes were down 9%. Demonstrating the flexibility and strength of the portfolio the Mexico and Caribbean team offset volume losses by seven points of mix improvement. Overall we executed seven points of pricing excluding glaceau and overall mix was slightly positive, again excluding glaceau. Year-to-date our CS dollar share is up 0.4 so our pricing strategy is working and more importantly it’s allowing us to recover commodity cost increases.

We continue to see cause for a case in line with our expectations. Gross margins for the quarter were down 40 basis points. The absence of lower margin glaceau products which we lost distribution of in November 07 benefited gross margins by about 130 basis points. Since we target pricing actions to cover the dollar increase in commodity costs, we are constantly looking at ways to crush costs. Year to date our manufacturing equipment effectiveness rate is up almost 4% and we’re seeing huge improvement in the area of safety. 16 of our plants have run accident free and over time this means greater up time and lower workmen’s compensation costs.

We also completed 56 lean [six sigma] supply chain related projects over the last 12 months and are starting to apply these lean techniques to other areas of our business such as financial back office processes.

Segment operating profit was down 2%. While we’re never happy with a declining profit story, it’s worth pointing out that we had $12 million of operating profit last year from distributing glaceau products which ended in November 2007. The absence of glaceau reduced segment operating profits by 4 percentage points.

As you saw in the earnings press release this morning we incurred a number of costs related to our separation. Excluding these items we earned $0.60 a share, up 7% from a year ago period. Year to date excluding these items we earned $1.01, up 16%.

In addition to delivering on our 2008 commitments we’re investing in new capabilities that will support our long-term growth. On June 18 we finalized an agreement to open a world class production and distribution center in Victorville, California at a total project cost of around $120 million this West Coast platform plant will support up to six production lines, 40 million cases, and have 550,000 square feet of warehouse space. It will provide critical finished goods capacity to support our planned growth and reduce our overall cost to serve in that market. We expect the center to open in the latter part of 2010.

We celebrated the opening of our new research and development center on July 23. The team successfully migrated R&D operations from Trumbull, Connecticut to our headquarters in Plano, Texas and still managed to produce outstanding new products like Venom, Snapple Antioxidant, and Canada Dry Green Tea Ginger Ale. We’re already seeing the benefits of having the state-of-the-arts center in Plano headquarters: Improved collaboration, faster decision-making, and greater commercial alignment and execution. While it’s too early to share our 2009 innovation plans, I can say our pipeline is strong and very exciting.

Also exciting is the recent deal we have signed with Hi Drive Energy to expand our distribution agreements in exchange for equity participation. This marks a shift in the way we approach building allied brands and allows us to participate more fully in their success.

We’re also seeing success in the market place. Our teams are embracing the winning and single-serve initiative. By keeping existing cold drink assets in service just a little bit longer, our field teams have converted cold drink maintenance cap ex into 5,500 new placements in grocery, mass merch, and up and down the street. The teams are also making progress for the feet-on-the-street pilot program which utilizes a small swat team to target certain stores with very specific product-selling mandates. Year to date this team has sold in over 60,000 SKUs and placed 1,500 pieces of cold drink equipment.

We’re also making progress in our goal to get Dr Pepper in every fountain outlet in the US and getting Diet Dr Pepper in every fountain that has regular Dr Pepper. Year to date we’re ahead of our installation plans and are proving that even in tough times consumers still want the great taste of Dr Pepper.

We’re making our marketing dollars work harder for us by doing everything we can to keep our brands in the news whether it’s Guns N’ Roses, the Bridesmaid on ebay, or even the Montauk Monster. I can’t tell you how much I enjoyed the obsessive branding disorder piece on Comedy Central’s Colbert Report on August 4, 2008. It was clear to me that Steven really enjoyed his Dr Pepper as he drank it slow, doctor’s orders. We’re also very proud to be named co-winner of the International CL Door Award for Best New Alcoholic Beverage Product with Chilata, the Budweiser and Clamato beverage.

We have an action packed second half in terms of impressions and innovation. We just kicked off our new Dr Pepper ad campaign: Trust Me, I’m a Doctor. Our research shows that to experience all 23 flavors in Dr Pepper you have to drink it slow. Who better to educate America than pop culture’s most famous doctors, starting with the most famous doctor in sports, Dr. J, basketball legend Julius Erving. This fully-integrated campaign will be everywhere from TV to billboards to cyberspace and will be seen more on the East Coast and West Coast as we continue our strategy to heavy-up media where Dr Pepper’s penetration isn’t as strong.

Dr Pepper will also kick off the college football season with a fun 21-ounce football-inspired bottle, a national on-pack 1 in 6 promotion and the opportunity to win big ticket prizes on national TV during the halftime of conference championship games.

Mott’s will center its back-to-school program around the building healthy families theme. It will be supported by a national [inaudible] featuring our portfolio of healthy products, a Catalina coupon program targeting the Light user, and print ads in national magazines.

In October we will bring back a new and improved 7UP Pomegranate limited time offer with a bonus, a diet version. This LTO will be available in 2 liter and 12-pack.

We will close out the year with two makeovers. First, the Snapple premium line will have updated flavors and a whole new look with a refined bottle. Second, Sunkist. For the first time in more than a decade Sunkist graphics will be updated to communicate more of its vibrant orange taste.

As I look ahead I’m confident in the strength and support of our brands and the power of our integrated business model. Limited exposure to colas and waters, the opportunity to add more to cold drink and fountain, strong innovation and marketing programs, new earnings opportunities through equity deals like Hi Drive, an execution mindset, and a relentless focus on crushing costs will all support our growth objectives for many years to come and will allow us to outperform the industry.

Our 2008 net sales guidance is unchanged, up 3% to 5%. We expect strong second half growth in Mott’s, Hawaiian Punch, and Clamato and will continue to benefit from the rollout of Venom, Snapple Antioxidant Water, and Snapple Mainstream. Our net sales guidance assumes no incremental pricing in CSDs. We are however monitoring the market place very closely and are ready to take action quickly. We are raising our four-year EPS guidance excluding certain items by $0.03 to at least $1.94. This reflects our confidence in the underlying performance of our business, upside from below-the-line items in the second quarter, and the ongoing benefit from tax planning initiatives.

In summary, a solid start to a life as a stand-alone company. We believe we have opportunities to increase the availability of our products and have well-crafted plans for 2008 and beyond.

Let me turn the call over now to John to walk you through second quarter below-the-line items and our 2008 outlook in more detail.

John O. Stewart

Let me start by highlighting three areas to consider as you review our results today.

First, for Q2 2008 we operated as a subsidiary of Cadbury until our separation on May 7, 2008 and thereafter we were a stand-alone company. Our results are thus part combo financials and part stand-alone financials. We’re looking forward to seeing our first pure stand-alone financial statements at the end of Q3 and I will remind you to wait patiently for Q3 2009 when we’ll finally see our first comparable stand-alone to stand-alone financials.

Second, as you know we have significant intercompany transactions between the segments. We encourage you to look at our results in total and this is how the information is being presented in the earnings press release this morning.

Third, you may have noticed language on our cash flow statement filed with this morning’s earnings press release detailing a reclassification of certain tax items from operating activities to financing activities. Let me say that our full-year 2007 cash flows were properly stated in our final Form 10 registration document. However, earlier versions of the Form 10 did not get this classification correct for the six months and nine months ending June and September 2007.

With that let me now provide some perspective on below-the-line items, cash flow, our opening balance sheet, and the outlook for the full year. There are several items to highlight in adjustments in the reconciliation from segment results to income from operations. Unallocated general and administrative expenses decreased $8 million as Cadbury allocations were lower than expected. Balance of year we expect unallocated G&A costs to be in line with our previous comments on Form 10 disclosures. Stock-based compensation also decreased $5 million. The second quarter 2008 charge reflects the year one impact of stock compensation costs versus a steady state rate. Included in other adjustments are a number of debits and credits which this quarter add up to a net gain of $6 million versus a net loss of $2 million last year. Combined with the loss and disposal of fixed assets these other items net to a $4 million gain. Transaction and separation related costs totaled $20 million for the quarter. These costs include new company branding, consulting services, management incentives, financial systems conversion, etc. and they are being expensed as they’re incurred.

We continue to expect full year costs to be about $35 million with the remaining $15 million hitting about equally in the third and fourth quarters.

Included within interest expense we incurred $24 million of fees and net interest expense in connection with the termination of a bridge loan facility that was established to effect the separation from Cadbury. Our tax rate for the quarter was 42.6% some 440 basis points higher than second quarter 2007. Improvements in the underlying tax rate driven by tax planning initiatives were offset by separation-related tax items totaling $10 million and items indemnified by Cadbury $2 million.

Cash from operations was up $41 million principally reflecting 2008 benefits of accelerated tax depreciation and the write-off of capitalized bridge loan costs arising from separation. Net working capital items were a slight negative driven by seasonality of the business and a higher inventory cost based on rising commodity costs.

Purchases of property, plant and equipment totaled $142 million. On May 7, 2008 the net settlement to Cadbury totaled $3.8 billion. This was funded using $3.9 billion of new senior unsecured debt which comprised $2.2 billion of term loans bearing an interest of LIBOR +2% or approximately 4.75% to date and $1.7 billion of bonds with 5, 10 and 30-year maturities with a blended average coupon rate of 6.81%. Additionally, we recorded $347 million of tax items in non-current liabilities under the tax indemnity agreement with Cadbury with a corresponding Cadbury receivable amount in non-current assets.

Cash and cash equivalents at the end of June were a little higher than normal reflecting the timing of separation related payments. In general you should expect to see a cash balance that reflects balances held in Mexico and Canada and roughly an additional $100 million to cover the liquidity needs of the business.

Moving on to guidance. As Larry mentioned we expect net sales growth in the 3% to 5% range. A challenging LRB environment and ongoing commodity cost pressures require us to constantly look at volume, price and mix levers to deliver on our commitments. Balance of year as Larry mentioned we expect stronger growth from our non-carbonated portfolio to drive overall mix improvement. However, we expect volume will be a little lower than the direction we provided on our Q1 call. The loss of distribution of glaceau products reduces volume growth by one percentage point.

Full year we expect the loss of our distribution of glaceau products to negatively impact net sales growth by four percentage points and the SeaBev acquisition to add one percentage point to net sales growth. At this point we fully lapped the net sales acquisition benefits from SeaBev.

For the year we continue to expect commodities to add approximately six percentage points to cost of goods sold and fuel to add $40 million to distribution costs. Both these numbers are broadly unchanged from our previous guidance despite significant volatility in our key commodities and oil in the intervening period.

While I’m sure a lot of you are anxious to understand our outlook for 2009, frankly it’s too early for us to provide commentary. We’ll start our 2009 planning process next month and we will come back to you with more details on our Q3 call in November.

We’re delivering substantially all the savings from the restructuring actions we announced in October 2007 but these savings are being offset by higher fuel costs, the consolidation impact of the SeaBev acquisition, and the new headcount and other costs associated with being a stand-alone company.

In line with higher cap ex we’re also seeing a step up in depreciation and expect full-year depreciation of approximately $140 million, again unchanged from our previous guidance.

Our full year tax rate is expected to be about 40% which includes separation related items of $11 million and tax charges that are indemnified by Cadbury of $10 million. As a reminder, we accrue and confirm Cadbury to offset the indemnity and record it as other income. Combined, the indemnity items have no impact on our total results. As you seek to calculate an underlying effect of tax rate for DPS, we believe you should exclude these items. The full year tax rate also includes about 50 basis points of rate improvement from favorable tax planning initiatives.

Our full year 2008 earnings per share excluding these items is expected to be at least $1.94 an increase of $0.03 per share compared with our previous guidance. As Larry said earlier this reflects our confidence in the underlying performance of the business and upside from below-the-line for tax planning items. Our EPS guidance is based on what we know today specifically as it relates to the impact of commodity cost inflation, interest rates, and tax rates. The excluded items totaled $0.29 per share and comprised transaction and separation related costs of $35 million or $0.08, bridge loan fees and expenses of $24 million or $0.06, previously announced restructuring charges of $43 million or $0.10, and separation related and other tax items of $11 million or $0.04.

Our cash flow is expected to grow in line with earnings and will be prioritized as follows: First, invest in the business and second, use free cash to pay down debt. We expect cap ex to be in the 5% of net sales range, unchanged from our previous guidance.

Given the continued cost pressures we are seeing we have stepped up our efforts on crushing costs. This will allow us to offset any additional economic deteriorations in the US and in the event that we realize incremental benefits we will seek to invest these dollars back in the business.

With that let me turn the call back to Larry.

Larry D. Young

At the halfway mark our results demonstrate the strength of our portfolio to outperform the market place. Dollar share is up and segment operating profit adjusted per glaceau is growing. Closing gaps to improve distribution and execution remains our greatest opportunity. And while this is not new news, we have the right team and the right processes in place to succeed. Our innovation continues to deliver for us and with comprehensive second half marketing programs our teams are ready to deliver against our full-year commitments. And finally, we are redoubling our efforts to crush costs wherever we can and remain ready to implement price increases as market conditions dictate.

We are ready to take our first question.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jonathan Feeney - Wachovia Capital Markets LLC.

Jonathan Feeney - Wachovia Capital Markets LLC

I know you don’t give quarter specific guidance but I’m wondering if you could tell us so we can see what the second half is now relative to the first half just in terms of the comparables, I was wondering if you could give us any more color particularly around gross margin; how Q3 versus Q4 is split out last year?

John O. Stewart

I think you shouldn’t expect any particular variation in gross margin between the quarters.

Jonathan Feeney - Wachovia Capital Markets LLC

On the capital expenditure, I know cold drink has been very much a part of your strategy. With an apparently deteriorating consumer, has it caused you to rethink at all some of the spending you’re doing?

Larry D. Young

No, it hasn’t at all. I mean, as I said in my remarks earlier, we are very underdeveloped in that area, our actual cold drink strategy goes into full force in 09. And this year we kind of shuffled some dollars around and the results were showing that the guys were delivering or making us even more confident in what we can do with it.

Jonathan Feeney - Wachovia Capital Markets LLC

Does it concern you that your bringing cold drink capacity if you will into places where others at the moment are experiencing tough results? You’re going to get this benefit and what makes you so confident that when you lap this benefit like you’re starting to do now and see it full force in 09, when you start to lap that what makes you so confident there won’t be some competitor response for example?

Larry D. Young

There are always competitive responses but whenever you look at our numbers, and we only have 12 pieces of equipment for 10,000 population, so what we’re doing out there is very obtainable and we’re staying where we got the high throughputs. But I think everybody’s got to look at the total picture on placing this cold drink. It’s just not getting the cold drink volume; it’s enhancing and building our brands. It’s getting our brand out there where people can pick this brand up everywhere they go. And if people are buying and drinking your brands at work, at play and recreation, when they go to that supermarket it’s going to drive more sales there also.

Jonathan Feeney - Wachovia Capital Markets LLC

You mentioned bottle and can being down. Can you tell us specifically what cold drink did this quarter?

Larry D. Young

Our cold drink was basically flat to up just a little.

Operator

Our next question comes from Judy Hong - Goldman Sachs.

Judy Hong - Goldman Sachs

Larry on the volume outlook for the balance of the year, if you could give a little bit more perspective particularly on the Snapple side. It looks like the second quarter trends were soft. Your guidance seems to imply that you’re going to see a nice pickup in the second half yet you’ve talked about increased discounting on the premium side. So can you just talk more about Snapple’s trend and the outlook for the balance of the year and why you’re confident that you’re going to see improvement?

Larry D. Young

I’ll just kind of go through all of them Judy and touch on the Snapple piece, too. I think on Snapple remember we’re just getting the Mainstream launched so that’s where we’ve got a lot of confidence in what the Mainstream will do. But if you look at it, we have very solid plans in place in the back half. Our non-carb portfolio will be led by strong support behind Hawaiian Punch and you’ve got to recall that we took significant pricing on Hawaiian Punch last April and we’re now growing off of the new base and we’re up 12% in Q2. We’re also expecting innovation lost earlier in the year and building healthy family packs to school programs to create strong interest in Mott’s. And our Clamato continues to gain fans to its Chilata product. Venom, Snapple Mainstream, Snapple Ox and Canada Dry Green Tea Ginger Ale are all doing extremely well and continue to gain distribution and they have a halo effect that is contributing to the base brands. Our company-owned distribution has already taken much of the needed pricing and will continue to benefit from favorable overlaps from the balance of the year. Additionally, Sunkist’s new packaging, Dr Pepper college football program and Trust Me, I’m a Doctor and the limited time offers on our 7UP Pomegranate, we really feel we’ll keep excitement in all of our categories.

Judy Hong - Goldman Sachs

And Larry in terms of more recent trends, we’ve seen gas prices come down more recently. Are you seeing any incremental improvement in consumers’ behavior in the beverage buying whether they’re buying more in convenience stores and gas channels now or are you seeing the broader industry trend improve more recently?

Larry D. Young

I think it’s still early to tell on that, but in conversation out in the trade and at major retailers I think people are feeling better about it.

Judy Hong - Goldman Sachs

John on the commodities, you’re not changing the 6% number at this point. How much are you covered for the balance of the year and are you starting to now look into locking up some of the commodities for next year?

John O. Stewart

On commodities it’s interesting because we’ve gone up in the intervening period and we’ve come right back down to pretty much exactly where we were at when we had the call with you in June. I can’t believe that people are celebrating oil at $115 a barrel. We have got to remember that we planned the year somewhere in the $70s. But what I would say is we’re not covered all the way through the year. We are covered most of the balance of the year but not all the way. We will look to take incremental cover at certain trigger prices commodity-by-commodity. And we have been relatively short covered for most of this year deliberately anticipating the beginnings of this I wouldn’t call it a bursting of the bubble but we’re hoping that the trends that we’re seeing in the last several weeks will continue through the balance of the year.

Judy Hong - Goldman Sachs

And just clarification because you talked about also finding other ways to crush costs as you put it, if oil goes back let’s say to $130 or $140, do you still have flexibility to speak to your guidance in light of some of the incremental savings that presumably are coming from the things that you’re looking at?

John O. Stewart

I’d remind you that we caveated the guidance with today’s knowledge on tax interest and commodities. We did that in Q1 and we continue to do that today. Clearly like any fiscally responsible company we are putting in place contingency plans for cost cutting should we have to face further increases beyond what we forecast for the moment, but we’re hoping we don’t have to go ahead and significantly look at costs further because that’s clearly a bad situation to be in. We’re comfortable that the plans we have today will get us through the balance of the year but incremental commodity costs increase we will just have to cross those bridges when we come to them.

Larry D. Young

Judy I think I might be able to kind of walk you through some of our productivity ideas for the balance of the year and also 09. If you walk around any of our facilities, you’ll see our vision statement. And in it, it sets two challenges for our teams: Grow sales and crush costs. Driving productivity is a way of life here. As I meet our people here at headquarters or out in the field, you hear every one ask “What did that cost? How can we get a better value out of it?” Now unlike some other companies we don’t set aside a big pool of money and then chase down productivity. We look for it in everything we do. I think a great example is in our supply chain where we adopted a lean sicsigma program a couple of years ago and it continues to gain traction. In the last 12 months the teams have completed 56 projects ranging from reducing warehouse breakage in Irving to improving the yield in North Lake to increasing the efficiency of our palletizers and aspers. All these projects drive productivity, not just as a one-time benefit but as a continuous improvement philosophy.

We’ve also taken this approach and are now starting to implement lean techniques in our financial back offices processes. We’re also investing in technology to drive efficiencies and common data standards. The organization is going through a SAP 6.0 upgrade and rolling out one common handheld platform. Now anything that excites me is wherever you look you’ll see improvement mindset and our entire team looking at “Let’s take action.” They all add up when you look at this business. I mean, the pennies turn into millions of dollars whenever you have the case base we have.

Operator

Our next question comes from Kaumil Gajrawala - UBS.

Kaumil Gajrawala - UBS

On pricing, do you have plans in place or maybe at this point are letters out for pricing post-Labor Day?

Larry D. Young

The guidance we provided this morning doesn’t assume any incremental CSD pricing in the balance of the year. Obviously we’re watching the market place closely and we’re always standing in and ready to act quickly. I think you heard me say earlier I believe we’re in a reset period so I think pricing and a relentless pursuit of costs are not a nice to but a must to. And our challenge now is how do you retrain the consumer and what’s important to us is to manage the price value equation but at the same time ensure we’re not too far out of sync with the market place.

Kaumil Gajrawala - UBS

Behind the question is that it looks like post-Labor Day you’re competitors are going to be going up quite a bit and if there’s no plans for incremental pricing is there a concern like maybe GAAP will widen or do you think there’s an opportunity to take further pricing if your competitors do go up as much as let’s say 8% to 10%?

Larry D. Young

If the opportunity is there, we will. I think if you watch, we’ve pretty well led price all year.

Kaumil Gajrawala - UBS

On savings, how much of your productivity in savings would you say has come from the integration and rationalization from the new bottlers versus productivity savings in the core business?

John O. Stewart

I think the way I’d look at that question is we have taken the best techniques in any one of our facilities and moved them across to all of our facilities. So we’ve had savings go from the old legacy businesses into the bottling group business and from the bottling group businesses into the old legacy businesses. So we’re not necessary seeing it in a particular P&L and that’s why we come back and always counsel you to look at the totality of our business. I’d characterize these opportunities in the way we characterize a lot of our business growth opportunities basic blocking and tackling. The operational effect of this measure is up 4% year to date so I would say we’ve got more to look for in that area and of course you know that the benefits coming from Southern California are still a couple of years away but we’re delivering on the initiatives we’ve put in place so far.

Operator

Our next question is from Damian Witkowski - Gabelli & Company.

Damian Witkowski - Gabelli & Company

On Mexico, the volumes are down more than I expected. Obviously you’ve taken price to make sure it’s a profitable business, but are you seeing any real consumer weakness in that region?

Larry D. Young

I wouldn’t say as much a consumer weakness. I think when you look at our Mexico business most of it was driven on higher pricing and as we got into the higher pricing it made our business much more profitable. The net sales in profit grew so the volume trade-off is something we’re willing to accept for now. It’s a very, very competitive segment down there and we needed to get some pricing.

Damian Witkowski - Gabelli & Company

And Larry in the US, you’re obviously up about 10% of your overall business in Texas and almost double that for Dr Pepper. Are you seeing the same trends in Texas or is it holding up better than the rest of the US?

Larry D. Young

I think the trend’s pretty consistent, yes.

Damian Witkowski - Gabelli & Company

I missed the cold equipment. You said you were ahead of schedule for this year. I know that starting in 09 the goal is to have 35,000 new cold equipment machines placed each per year, but what’s the goal for 08?

Larry D. Young

In 08 what we’ve done is we’ve just shuffled some of our maintenance cap ex, sweat some of the assets a little longer, [inaudible] of sweat mask and using that money to go after some incremental.

John D. Stewart

And you know our goal has always been to maintain that base out there of 200,000 to the extent to which we can if you will sweat that base a little bit longer. It frees up existing base maintenance cap ex to do the 5,500 that Larry has talked about. But that would be incremental to our 35,000 a year that we’re starting next year.

Damian Witkowski - Gabelli & Company

You said food services was positive for the quarter?

John D. Stewart

Yes.

Damian Witkowski - Gabelli & Company

Are you surprised with that or what’s driving that? It’s been slow for others.

Larry D. Young

The great taste of Dr Pepper.

Damian Witkowski - Gabelli & Company

Good answer. Are you in more doors? Is it more same store sales or is it just more doors?

Larry D. Young

We’ve had a plan to close the gaps out there now. It’s the guys are ahead of where we thought they’d be. They’ve done an excellent job of getting more valves out there and getting our Diet Dr Pepper on where we have Dr Pepper on the fountain.

Operator

Our next question comes from Bryan Spillane - Bank of America.

Bryan Spillane - Bank of America

Two questions relative to how you’re approaching your planning for 09. First, CCE is going through a 120-day review period right now and to the extent that they’re a large franchise for Dr Pepper, how that may play into your planning for 09? And then the second thing is, some of your competitors are contemplating some pretty major or potentially major shifts in packaging, moving away from the 20 ounce, playing with packaging configurations in take home channels, and so again how does that effect your planning for 09 and are you going through a similar review in terms of looking at packaging configurations and potentially making changes?

Larry D. Young

Absolutely. We watch this every day and we work very, very closely with our bottling partners. And as they put their plans together we work with them; we make sure we plan together; we want to drive everything we can. And in certain markets where package changes make sense, we do it; we look at it. But we have a tremendous amount of consumer insights come in that we look at and study that will tell us how we want to go commercially. We share that with our bottling partners and we do what the customer’s looking for out there so we drive the most benefit into the consumer’s hands. We plan very well together; we look at all those things; we’re involved in their planning process on our brands. And on our planning I’ll kind of hand it over to John to let you know what we’re looking at in 09.

John O. Stewart

We’ve said this at other investor presentations and I think it’s important to re-emphasize it. 2009 is going to become our first real base year on which you can apply our long-term algorithm of circa 3% to 5% net sales growth and high single-digit EPS growth. There are a couple of things you should be thinking about just now if you’re going to build a 2009 model. Interest income will be negligible going forward given that we’re targeting a circa $100 million flow plus whatever is sitting in Canada and Mexico, so only around $4 million of interest income versus what we’ve historically had in the $25 million to $35 million zone. Clearly our stock compensation costs you’re only seeing a partial year one cost in this year and as we go into next year that will jump to year two levels of circa in total $20 million to $25 million and then by the third year we’ll be at a steady state of three years of grants. And our unallocated G&A as we build and finalize the build of our corporate organization, that will ramp up to the $45 million range. So when I look at the delta today it’s around about $50 million of stepped up costs to make us a truly stand-alone company and make 2009 the true base year. So those facts we know about today. Operationally we’ll come back to you Q3 call with the outlook.

Bryan Spillane - Bank of America

Larry one of the ideas that’s being kicked about is that the 20-ounce package is too expensive and it’s too much liquid. What’s your perspective on that because it obviously has profit implications? It’s the most profitable package for most bottlers. I’m assuming it is for your bottler as well. What are the risks or the considerations that go into tinkering with that as a primary profit driver for a bottler?

Larry D. Young

Especially in our company-owned distribution we’re not seeing as many problems with the 20 ounce because as I said we’ve got much more opportunity in the cold drink. Also when you take your heavy consumers, a lot of our cold vaults have one liter in them. So we have a pretty broad mix out there. We have 12-ounce PT, half liter, 20 ounce, and one liter. We’re monitoring it really close but most of our markets are still very heavy into the 20 ounce. We have some out there that have done the 16 but it’s still a little too early for me to tell. Because you’re right; it can have an impact on the profitability. You’ve got to make sure you get the price/mix equation right in there with the profitability.

Bryan Spillane - Bank of America

So it’s fair to say from your perspective the 20-ounce package isn’t broken?

Larry D. Young

Not for us.

Operator

Our next question comes from [Pria Oregupta] - Lehman Brothers.

[Pria Oregupta] - Lehman Brothers

I was just wondering if I could follow up on your cash flow comment. I believe in the past you had said that you would look to pay down in excess of the $165 million in minimum obligations related to your debt. I wanted to find out if that was still the case. And secondly, I wanted to know if you have a specific EBITDA target associated with your desire to move to a stable outlook with S&P by year end.

John O. Stewart

It is still the case. We absolutely intend to use whatever we have excess over and above that circa $100 million float and over and we will obviously have a certain element of Mexico and Canada cash that isn’t readily accessible, but above and beyond that we want to use everything we can to pay down debt. As I said to several of you when we’ve been out and about, we would anticipate being back to the rating agencies probably towards the end of this year or early next year and it will be up to them obviously to give us their opinion on rating. But we’re certainly looking to target the removal of our negative outlook as soon as we can possibly get it and that’s why we’ll have this big focus on paying down debt.

As to EBITDA, we do not have a specific target for that.

Operator

I would like to hand the floor over to management for any further or closing remarks.

Larry D. Young

If there are no more questions, I’d like to thank you for your time and your interest in Dr Pepper Snapple Group. Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Dr Pepper Snapple Group, Inc. Q2 2008 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts