百事 (PEP) 2003 Q2 法說會逐字稿

At this time, I'd like to thank all parties for holding.

Your lines will remain on listen-only until the question and answer session of today's conference.

Today's conference is being recorded, if you don't have any objections you may disconnect at this time.

At this time, I would like to turn today's conference over to SVP of Investor Relations, Mr. Jack Callahan.

Sir, you may begin.

Thank you, Operator, and thank you, everyone, for joining us this morning.

With me today are Steve Reinemund, our Chairman and CEO, and Indra Nooyi, our President and CFO.

In addition, we have present the Chairman and CEO's of our three operating divisions: Gary Rodkin of PepsiCo Beverages and Foods, Mike White of PepsiCo International and Al Bru from Frito-Lay, North America, who is joined by his CFO, Dave Rehr.

All the participants will be available to answer questions after the prepared remarks by Steve and Indra.

Since our earnings were released earlier this morning, we will assume that you have all read the release, which is posted on our Web site at www.pepsico.com.

Before we begin, I have a couple of administrative matters to attend to.

First, this call is being web cast and can be accessed via a link on our Web site.

The call will also be archived for 90 days at our Web site and at streetevents.com.

A tape replay will also be available until the close of business on Friday, July 18th by dialing 888-216-4454.

International callers should dial 402-220-3883.

The reservation number is 12588.

For anyone calling in with follow-up questions after today's call, please call me, Jack Callahan, at my new number, 914-253-3035.

Second, volume, which is not a financial measurement, will be discussed excluding the impact of divested businesses to provide a consistent year-to-year comparison.

Furthermore, for the most part, we're going to be discussing our earnings today on a reported basis.

This is being done to minimize our use of non-GAAP measures.

However, in answer to questions and from time to time in discussing our financial results, management may refer to certain non-GAAP measures, particularly those we have historically referred to.

A reconciliation of these non-GAAP measures to PepsiCo's reported financials can be found in the investor section of our Web site at www.pepsico.com under financial releases.

Next, as we discussed last quarter, we have made some changes in our reporting segments as well as a change in reporting periods for the North American Quaker businesses.

These changes do not affect full-year consolidated numbers.

We have summarized these changes in the investor section on our Web site where we have also posted adjusted historical information to present prior year information on the same basis as 2003.

Finally, I'd like to read our cautionary statement.

This conference call may include forward-looking statements based on our current expectations and projections about future events.

Our actual results could differ materially from those anticipated in any forward-looking statements.

But we undertake no obligation to update any such statements.

Please see our filings with the Securities and Exchange Commission including our annual report on form 10-K for discussion of specific risks that may affect our performance.

Now it is my pleasure to introduce Steve Reinemund.

Thank you, Jack, and good morning.

Thank you all for joining us this morning, and as has become our practice, we're not going to review all the numbers that we set out in the earnings release that we issued this morning.

But I would like to take an opportunity just to review the headlines.

We had excellent top line growth, solid bottom line results, and a portfolio that works.

And that's simply what the second quarter was all about.

We're very pleased with our second quarter performance, especially in view of difficult current economic and retail environment that we find.

All four operating segments contributed to the strong top line performance, driving worldwide servings of our products up almost 5% for the quarter and total net revenue up 7%.

And this strong top line performance yielded solid bottom line results.

Our EPS of 58 cents was 19% higher than our second quarter last year, and it was in line with consensus.

With lower merger expenses contributing about 5% points of that EPS growth.

And remember PepsiCo is not just beverages and not just snacks but a portfolio of complimentary businesses.

So when the portfolio delivers a strong bottom line, it's possible for us to fund selective investments as well as offset modestly higher than expected inflation and still deliver superior performance in total.

As I mentioned earlier, we delivered this performance in spite of a stagnant economy and very challenging retail environment.

I'm going to spend the balance of my prepared remarks on two areas within the portfolio that I know are on your minds.

First, Frito-Lay North America.

I want to spend a moment taking you through the excellent top line growth and the strong price realization and then explain why profits only grew in line with revenues this quarter.

After that, I want to take you through the strong quarter delivered by PepsiCo Beverages North America.

I'll spend a moment discussing the successes at the division and then we'll go through some of the challenges that we face and our plans to address those challenges.

Let me begin with Frito-Lay North America, which has as you saw in the release had very strong top-line results.

Frito-Lay's second quarter volume approached 4% and net revenue grew 6%.

Strong performance across the board was driven by both Fritos' core salty business as well as its add-more convenience business.

Core Salty had excellent growth, growing close to one share point in measured channels.

Growth was led by Cheetos, where we had strong great shape innovation with twisted Cheetos, we had effective in-store promotions, and good media support.

Doritos also had strong growth, and it was driven in part by the success of Doritos Salsa, which as you know was introduced last year.

I believe Doritos also benefited from the move we made to remove all Trans-Fats from Doritos.

Al Bru and his team at Frito-Lay led the industry in this action, and I'm proud to say that we now have zero Trans-Fats in Doritos as well as most of our other products at Frito-Lay.

And if you want to check that out, just look at the labels on the shelves in the stores today.

The Doritos brand also grew as a result of the strong success of baked Doritos, now available in both Nacho cheese as well as Cooler Ranch flavor.

In fact, the entire platform of baked products had strong double-digit growth, which attracted consumers who want great-tasting products with significantly less fat content than our indulgent products.

And our all-family product offering continues to be strengthened by the explosive growth of Munchies Snack Mix.

We gained close to 14 share points in the party mix category during quarter 2.

Furthermore, snack mixes will be an exciting platform from which to innovate on both form as well as flavor.

For example, we recently introduced our first better for you variety of Munchies with Quaker cereal components included.

The natural and organic line of Ruffles, Tostitos, Cheetos and Lay's that I discussed in the quarter 1 conference call is performing very well and looks to be highly incremental due to Fritos' success in gaining additional space in the natural foods section of grocery stores.

The convenience foods division continues to add more to the Frito portfolio by leveraging both the DSD as well as the warehouse selling and delivery systems.

In fact, our add more portfolio of products had double-digit growth.

In the warehouse system, the chewy and fruit note meal portfolios continue to expand due to a strong pipeline of innovation including chewy wholesome favorites and fruit and oatmeal toe sables.

And within the direct store door, delivery system Alberto our entry into the fast growing dry meat category continues to grow.

Across both our core salty and convenience foods divisions, better for you products collectively grew almost 30%.

As we've said before, we consider our balanced portfolio of offering both indulgent and better few products provides a real competitive advantage in this environment.

I also want to spend a minute taking you through the improved spread between revenue and pound growth.

With pounds at about 3.5% and net revenues growing 6%, Frito-Lay had strong positive spread between volume and revenue.

This spread was due to innovation, including some of the news I've just talked about, and more efficient promotional spending in our core salty business.

This positive spread would have been even larger but for the slotting investments we made to launch this year's convenience add more news through the warehouse system.

So with a positive spread on the top line, I'm sure many of you are asking, why did Fritos' profits only grow in line with sales this quarter, and what kind of profits can Frito-Lay deliver on a sustained basis?

Let me address the second quarter first.

In a nutshell, the reason for the second quarter result is that some investments as well as unplanned inflation hit the quarterly profit performance.

To give you some additional color, these incremental costs were in three principal areas.

First, our energy cost, especially fuel and natural gas, increased well beyond what we had planned.

For example, our natural gas costs were 30% higher than we had expected.

You all know the causes for this type of inflation.

We've talked about them before.

The war, the shutdown in Venezuela, and the unusually long and harsh winter.

We believe fuel costs should stabilize in the back half of the year, and we have hedged our position in natural gas through next winter.

Next, as we previously discussed the move to non-trans fatty corn oil is costing more during this transition year.

Because of the timing of our announcement and the rush by others to follow our lead, there was a shortage of corn oil in the market.

As a result, corn oil cost increased significantly.

Longer term, the supply of corn oil should improve and will begin to leverage our proven purchasing capability to manage these costs.

Third, the delay in the start-up of the stacks lines cost Frito-Lay both in terms of incremental start-up costs and in loss contribution from planned sales during the second quarter.

I'm happy to report that we've started production on stacks and that we'll be introducing this product soon.

Let me put all this into perspective.

The unexpected incremental costs were more than $10 million, and it cost us about two percentage points of operating growth at Frito-Lay.

To me, this illustrates the value of having a strong portfolio like ours.

Due to the upsides in our other businesses, we were able to cover the higher costs and still make planned investments as well as deliver a strong 58 cent quarter.

Going forward, even though we expect these higher costs to persist into the third quarter, the more efficient promotional spend versus year-ago alone will give us the difference between a 6% and an 8% profit growth for Frito-Lay North America.

In addition, we had the remainder of the convenience add-more innovation that will be introduced in the third quarter, including an exciting new bar platform called oatmeal on the go.

It's been a proven success in Canada, as well as new chewy trail mix granola bars, a new entry into the fast-growing bar segment.

And in the fourth quarter, we'll have the incremental growth from stacks as this terrific new product will be in the marketplace.

So to sum it up, we remain very confident about Frito-Lay.

In the second quarter, we had very strong top line performance and more efficient promotional spending and thanks to our portfolio.

We are able to continue making investments to drive the business toward continued success.

Now, longer term, I believe that normally, Frito-Lay is capable of and I would expect Frito-Lay to deliver around 8% growth.

Of course there will be challenging years and there will be windfall years, but on average, Frito-Lay has a very healthy business model with bright prospects.

Now turning for beverages, we were extremely pleased with the second quarter performance of our North American beverage portfolio.

Our second quarter results exceeded expectations with servings up over 4%, sales up 7%, and profits up 10%.

We delivered good CSD results while also driving growth in the important non-carbs.

PepsiCo's CSD's grew ahead of the category, and that growth was led by Sierra Mist and Mountain Dew.

The national launch of Sierra Mist continues to be a success.

We've expanded our distribution to over 90% of the country and we're holding steady at a 1.7% share.

We're already larger than seven up in new Sierra Mist markets, and nationally, we're fast becoming the number two lemon-lime.

And this is extremely important.

Sierra Mist is now not just another new product.

It's a brand platform.

It gives us three major brand platforms.

Pepsi, Mountain Dew, and now Sierra Mist from which to innovate and grow.

Now let's talk about Mountain Dew.

Mountain Dew delivered solid growth in the second quarter.

As anticipated, we have seen a big improvement in our Dew trends as we rolled out Live Wire, which is an orange ignited flavor that will only be available this summer.

We've worked with both our bottlers to bundle merchandising across the entire Dew trademark throughout the summer.

For example, if you've been in the stores, you've probably noticed that Mountain Dew has been supported with a tie-in with one of our summer -- big summer movies, "The Hulk" from Universal Studios and as the result of this activity, Live wire has improved volume performance for regular Mountain Dew as well as Code Red.

Now over the performance of brand, Pepsi remains a concern.

Trademark Pepsi's second quarter results were not where we wanted them to be, largely due to a disappointing brand Pepsi performance.

Balance of the year, we have some great products news that will help grow our cola business.

Next month we'll be introducing Pepsi Vanilla in both regular as well as in diet.

Pepsi Vanilla is a more balanced blend of Vanilla and Cola without being too sweet or overly satiating.

We'll bundle much of the in-store Pepsi Vanilla launch tactics with our reformulated Pepsi Twist to generate trial and volume on Twist as well as Vanilla.

We've also tested several canned packaging configurations, and we're hoping to introduce a reconfigured 3 x 4, can twelve pack called frig-made.

We also expect to continue to benefit from the Pepsi "play a million" promotion, and we'll be able to capitalize on our NFL partnership with a joint Pepsi Frito-Power One event to kick off the NFL season.

Let me shift gears now and talk about our leading non-carb portfolio.

In the second quarter, non-carbs grew 8% led by the Gatorade family of brands.

Gatorade had a strong quarter with mid teen volume growth even as the weather was milder and wetter than usual.

With a summer selling season, we put a number of strong in-store initiatives combined with packaging news and outstanding advertising.

This will ensure that we continue to grow and gain share during the heart of the season.

In addition to base Gatorade growth, we continue to experience great success with Propel fitness water, now in the second year of natural distribution.

Propel continues to lead the emerging enhanced water category with shares two to three times the size of its nearest competitor.

Now to Aquafina.

Aquafina delivered double digit volume growth while maintaining its rational pricing architecture in the face of very aggressive pricing actions by competitors.

We intend to continue to build this brand through our just launched first ever-national promotion for Aquafina.

It's called "Get spotted and win" it is very simple.

During this promotion, consumers spotted drinking Aquafina will win prizes.

Coupled with packaging news, this promotion will ensure Aquafina keeps growing at a healthy clip.

On to Tropicana.

Tropicana continued to execute against the recovery plan that we set in motion last year, re-establishing pricing and promotional strategies that will be more sustain sustainable and more profitable for our customers and for us going forward.

Tropicana has also worked to refocus the consumers on the taste superiority of our product.

The challenging juice category remains sluggish but Tropicana has been gaining share despite increased competition.

So in summary, PepsiCo beverages had a strong second quarter thanks to great execution, we delivered good results in a very difficult retail environment.

And what we fully plan to continue to outperform the category in order to main maintain this superior growth rate, we need to see some sustained improvement in retail channels, especially large format, as well as the cold channel.

With that now, I'd like to turn the call over to Indra, who will take us through a few corporate items.

Thank you, Steve.

I'm very pleased with our financial performance both at the operating division level and at the corporate and financial leverage we delivered.

Our finance team does a pretty good job managing the corporate costs, overall capital spending, capital structure and tax planning to maximize our cash flow and return on invested capital.

This morning I'm going to spend a few minutes talking about a couple of items below the division operating profit line.

First, corporate costs.

Our core department expenses were roughly flat and we're continuing to invest in the business process transformation initiative we shared with you at our conference in February.

We expect our spending on this initiative to ramp up as the year progresses, but as we mentioned at the conference, we intend to fund this on a pay as you go basis.

Our corporate unallocated line increased principally as a result of higher expenses relating to deferred compensation programs and employee benefits.

You also probably noticed that our net interest expense declined significantly.

Most of this decline is a result of gains on investment funds that largely offset the deferred compensation increases.

Net interest expense on the remainder of our debt balances increased a modest 7% for the quarter, with this increase due principally to the resumption of our share repurchase activity.

We have been actively repurchasing shares through July 7th of this year, we purchased 11.7 million shares for a total of about $500 million.

Our average shares outstanding for the quarter were down 3.5% versus the second quarter of 2002.

Since the inception of the $5 billion repurchase program announced in July of last year, we have repurchased 65 million shares for a total purchase price of $2.7 billion.

And remember, we bought about 30 million of those shares in the third quarter of last year.

So next quarter, we'll be lapping that big share repurchase and we'll get a little less leverage below the line.

We plan to spend another $1 to $1.5 billion repurchasing shares through the balance of 2003.

Margin expenses are also on track.

We incurred approximately $11 million of restructuring costs in the quarter.

Most of that was severance-related.

We still project total cost to be around 50 million for 2003, which is about 3 cents of earnings per share.

Now let me turn to cash flow.

Cash flow from operations net of capital spending was $1.1 billion through the first half of the year.

And we are on track to deliver $3 billion for the full year.

Our year-to-date cash flow performance was about $370 million lower than in the first half of last year.

Let me spend just a moment on this.

First, capital spending is up 70 million in the first half of 2003 versus the same period in 2002.

This increase is principally related to spending on the second Ireland concentrate facility and the Stacks project.

Second, working capital.

The timing of supply payments principally related to A and M resulted in a higher use of cash in the first half of 2003.

At the end of 2002, our accounts payable were higher than usual by almost $200 million.

In the first half of 2003, they have been brought down to our usual levels.

Let me then draw your attention to the fact there's always a seasonal build of inventory in accounts receivable in Q2.

Having said that, I'd like to point out that our divisions carefully monitor accounts receivable, inventory, accounts payable, and performance as well within our targets.

And lastly on cash flow, we are facing a very tough comparison.

Our first half 2002 performance was unusually strong, up significantly versus the same period in 2001.

Again, as I said earlier, for the full year, we are on track to generate about $3 billion of cash from operations net of capital spending.

This amount assumes capital spending for the full year of approximately $1.5 billion, and $400 to $500 million of pension funding.

Our final decision on the exact amount of pension funding will be made in the fourth quarter.

The combination of our strong cash flow, capital spending controls, and working capital management has been the key driver in our return on capital performance.

As you can see this quarter, we saw a reported ROIC jump to 28%.

That's an improvement of 150 basis points since year-end.

The principal driver of this increase was NOPAT although the reduced merger cost did contribute about 50 basis points to the growth.

As I'm sure you can imagine, we are very pleased with our continuing improvement in this important ROIC measure.

Turning now to EPS for balance of the year, as you know, we are no longer giving quarterly guidance.

However, looking out over the balance of the year, because of the way corporate leverage is timed, I can tell you that you should expect the fourth quarter to be stronger than the third quarter from a growth rate perspective.

Having said that, I want to confirm as Steve said in the earnings release that in spite of the difficult environment in which we operate, we remain comfortable that we'll have earnings per share of between $2.16 and $2.19 this year and that includes approximately 3 cents of merger costs.

Excluding the impact of merger costs, we continue to expect that full year 2003 EPS will be in the $2.19 to $2.22 range, which I believe is consistent with consensus.

Now it's my pleasure to turn the call back to Steve Reinemund.

Thanks, Indra.

Before I open up the call to questions, let me make one final comment.

I'd like to thank our people everywhere around the world who despite this very tough environment, made sure that PepsiCo delivered another solid quarter.

We believe our businesses are sound with great plans for the future and more importantly, great people who are excited about implementing those plans.

Now hopefully we've addressed the principal issues in our prepared remarks, and in order to make sure that we address all of your questions, I'm going to stop now and open the floor to Q and A.

At this time, if you wish to ask your question, please press "*1".

That's "*1" on your touchtone phone to ask a question.

Your first question comes from Jeff Kanter from Prudential Equity Group.

Sir, your line is open.

Good morning.

Question for Al or Steve.

How much did the slotting fees impact the top line at Frito-Lay North America?

And was there any benefit at FL and A from the Pringles disruption?

Is there a way you could quantify that?

Let me try to answer the Pringle one, I don't think there's any way to really quantify that particular number.

It was a temporary disruption as I think you all know, they're back up and operating.

As far as sliding fees are concerned, I'm not sure how valuable it is to get into the details of that, Jeff.

I would just say that we planned it on a yearly basis.

We're very happy with the products that were coming out, and you'll see most of those coming out in the third quarter.

Ok.

Fair enough.

Indra, you said that you resumed your share repurchase.

It looks like in the second quarter, the decision was to pay down a little bit of debt at the expense of share repurchase.

Can you tell me what drove that decision?

Because I would imagine that buying back stock is more accretive than paying down debt.

The interest rate on that debt was pretty high, Jeff, so we decided to make a decision to pay down some of that debt and our decision was always to use available cash to buy back shares and we used available cash in the U.S. to buy back shares.

You'll see a significant ramp-up in share repurchase activity in the third quarter, and I said balance of year, we are going to spend another $1 billion to $1.5 billion buying back shares.

So I think our share repurchase program is healthy and well in place.

Steve, I know that you're committed.

I know you've said that you're committed to the Quaker brands, but some of these other brands in Quaker Foods North America do have identities of their own.

As we approach this two-year anniversary, can you talk about any potential divestiture options?

Well, Jeff, as you know, we made some small adjustments to our Quaker holdings over the past year with Mission Pasta, bagged cereals and some small businesses in Latin America.

However, we don't have any immediate plans to sell the rest of the Quaker food businesses.

In fact, we see a lot of value in the Quaker food businesses.

The cereal businesses provide strong platforms for growth in the snacks category and as well as the breakfast day part, which we saw -- certainly saw it in the first quarter.

And the Quaker brand is a significant component of our good for you and better for you portfolio, and these businesses, as I've talked about several times in the past, provide additional scale for our combined sales force through the warehouse.

And I might add as I'm sure all of you are quite aware of these businesses have strong cash flow.

So, you know, we'll make some slight adjustments over time as we see necessary, but we don't have any immediate plans.

Thank you very much.

Your next question comes from Bill Pecoriello from Morgan Stanley.

Your line is open.

Good morning, everyone.

My question is regarding the big increase in trade spending going on in general for all suppliers to large format food channel.

Can you address the differences between the part of the spend that's going to gaining more real estate because you're under spaced relative to the returns of your products, and also the space that you need for the innovation pipeline versus the higher trade spend suppliers are making to subsidize the profits of these declining food retailers, and about 40% of that is not even getting passed on to the consumers?

Well, Bill, that's a tough question.

I'll try to take a stab and I'll ask Al and Gary if they want to add something to it, but the trade spending is affected differently between the warehouse and the direct store door delivery systems, as you know, and in the trade spending that we deal with in DSD is really in promotional trade spending, whereas, you know, the sliding fees is really more often than not a spend that buys us space but doesn't necessarily go back to the consumer.

Since we're in both businesses, it really does affect us differently.

But, you know, this has been a year where we've focused as a company across the board both domestically and internationally on watching this trade spending more closely and making sure that we're getting everything we can out of it.

In fact, we've worked very, very hard against that across all of our businesses, and we're quite happy with the positive results we're getting both in the top line as well as more efficient spending.

So I'm not sure that I've answered your question, but it s a complicated one.

It's one that's top in mind or us as well as other manufacturers, but we feel hat this year, as contrasted maybe even to last ear, we've made some real good progress.

I don't now, Al or Gary, if you want to add anything to hat.

Bill, this is Al.

One of the things that we have been able to achieve this year with the new product portfolio that is coming along is getting additional space in different aisles of the stores.

As you know, DSD in our case, there's no charges attached to getting that additional space, so natural organic line went into additional space, some of the meals that we're about to launch are going into additional space, and as Steve pointed out, most of the DSD trade spend goes into items that are passed on to the consumers.

So that has allowed us to be more efficient this year than ever before.

And Bill, it's Gary.

It is a tough environment out there.

We are trying and I think we've done a good job in some of our categories in particular, say on the CSD front, of getting some very strong customer specific programs, so we're trying to orient the strength of our brands, the strength of our properties with some of our key customers.

So that's certainly a high priority for us.

We've got to get the right price value obviously in this tough environment, and the right real estate, as you mentioned, is critical as well, so there is money spent across the board, and it's significant, but we also, I would tell you, clearly see opportunities for productivity in this spend.

But it's really important to remember that when you have the strength of the brands and the strength of the go to market systems that we have, we're probably in a little better position than most.

Thank you very much.

Your next question comes from Michael Branca from Lehman Brothers.

Your line is open.

Thank you, and good morning, everyone.

If we could get back to Frito-Lay North America, I'm hoping you could give us some sense as to the impact on the price factor from mix of the single serve business, particularly since in the first quarter, you had the impact from lower traffic in the C stores, I'd like to understand the level if that's continuing.

And second, at Frito-Lay North America, plainly your accounting for the marketing spending alone projected sales curve, and Steve, a couple of times you mentioned the effectiveness of in-store promotions.

Does that mean you're getting the expected lift from those initiatives or that in the first half, you got more than the expected lift from those marketing initiatives?

Let me answer the second one and then, Al, why don't you pick up the single serve question.

But we focused a lot of our attention, as I said earlier, on effective trade spending this year and we do think that Frito has made great progress in getting that both passed on to the consumer and in seeing a lift in our business.

I'd say from my perspective, and Al may want to add his editorial here, but I think from my perspective, the trade spending has worked so far this year, and I would anticipate that that effectiveness would continue through the balance of the year.

Al, I don't know if you want to deal with the single serve question?

We have seen an improvement in our single serve performance on the basis of the news that we have introduced, and I would tell you that the trends that we're having right now are very encouraging in the single serve side of the house.

However, there is softness out there as Gary pointed and as Steve pointed out before, but on the strength of the meals that we're rolling out, we are seeing improved performance on the single serve side of the business.

And that shows on the overall results for the quarter.

But you see it picking up momentum?

Yes, we're picking up momentum in the UVS side of the business on single serve.

Thank you very much.

Your next question comes from Bonnie Herzog from Smith Barney.

Your line is open.

Good morning, everyone.

I guess my first question is on Frito-Lay, and I'd like to drill down a little into your indulgent business.

Considering that your entire better for you portfolio was up a very impressive 28% in the quarter that would imply that everything else or the indulgent piece of your business was down slightly.

And it appears that this trend may be declining slightly on a year-over-year basis.

Can you talk to this and confirm if I'm looking at this the right way, and then maybe highlight what is going on in your indulgent business and innovation there?

And then I do have just a quick follow-on question on pricing.

Since other than volume growth, a lot of your top line growth was a result of the growth again in this better for you business, which achieves a higher net revenue per pound, can you give us an idea of how much higher your better for you net revenue per pound is or, I guess, was and what the recent trends have been?

Well, Bonnie, let me put your mind at rest.

We got growth from our full portfolio.

We roughly got over half of the growth came from better for you, so as a percentage on a much lower base, it was high, and it had a big impact over half of the total growth, but the other almost half came from the rest of the portfolio.

So I want to stress the fact that we have and we continue to believe that our total portfolio is a huge advantage, the consumers want choice, and we're going to continue to innovate against and market against a total portfolio.

And just to put it a little on it, in my opening comments, I talked about Doritos and Cheetos specifically, and those products are doing very well, and they're doing very well in both sides of the house.

In the Doritos case, baked Doritos is doing well and the regular original Doritos is doing very well.

So I think what you're seeing is the consumers do want a choice, and as a percentage, clearly we would see for the near term a higher growth rate coming out of better for you.

And to your second point, out let I'll pick up the second half of the second point, but in the second point clearly the better for you is giving us pricing upside because the margin -- because of the price per pound difference in better for you.

But Al?

Well, I believe the question was what percentage that are you getting out of the premium side of the portfolio, and that is almost one-third of the pricing that we're getting from price mixes coming out of the premium portfolio.

Okay.

So the premium portfolio is working very well for us.

It's obviously generating a higher net revenue per pound, just like your average core salty business.

Yes that is correct.

Are you comfortable giving us a number?

No, because those numbers can change at any one point in time so, but we are getting very encouraging news and what's very important to us, the fact that we made this big change out of Trans Fats, I can tell you that 99% of the salty portfolio in the U.S. is that Trans Fats -free for salty chips in the U.S.

Okay.

And then I just want to be very clear on the -- can I break your business into better for you and indulgent, and then estimating would better for you represent in terms of the total mix, is it about 15% of your total portfolio?

Bonnie, you're pretty close.

Okay.

All right.

That's very helpful.

Thank you so much.

Your next question comes from Mark Swartzberg from Legg Mason. your line is open.

Thank you, Operator and Good morning, everyone.

Steve, two questions for you regarding uses of cash flow, and they are by my admission here from the vantage point of someone who thinks you should be materially increasing your dividend pay out ratio.

The first is regarding Share Repo, it looks like it slowed considerably in the second quarter.

I'm trying to understand if I should view that as a view of where you think your stock is attractive in terms of stock price, why you'd be accelerating it again in the second half given your comments about the level of dollar spending you planned in the second half, and then secondly, it seems fair and maybe this is the wrong assumption but it seems fair to expect your staples peers out there to continue to increase their dividend pay out ratios.

I think you're already below your peers right now.

As u see that increase if indeed we do.

What's your attitude to seeing that happen?

Well, you addressed the question to me, and I'll take a very short stab at it and then I'll ask the expert here, Indra, to give her point of view.

But the share repurchase in the first half has really been more against what Indra said earlier, which was our stated goal of buying back with available cash.

So it's really been more that than anything else, and I wouldn't read anything more into it.

But again, I'm referring particularly in the second quarter, it slowed down considerably at a time when cash flow was picking up markedly.

Right.

And, you know, on a very, very short-term basis, we have standard rules in place, and we didn't change direction.

We just didn't make those purchases.

But we will be in the second half and I'll let Indra talk more about that.

Mark u you've got to be very careful how you look at our share repurchase program.

Most importantly, what we said was we weren't going to borrow to buy back shares, we were going to use available cash.

Having said that, in Q2, of course we had available cash.

We used some of it to retire some debts, which had high interest rates because we thought that was a prudent thing to do with interest rates coming down.

Secondly, there's cash and there's cash.

We usually buy back stock from cash in the U.S. because cash that's sitting outside the United States, we don't try to bring it back unless we can do it in a tax-efficient way or if we need the cash for international activities, we leave it internationally.

So in Q2, based on the grid that we put in place and based on the available cash, available in the United States, we executed the share repurchase program.

Going into Q3 and Q4, we're going to have a lot more cash, and so we're going to ramp up our share repurchase activity, and we're going to buy back $1 billion to $1.5 billion of stock.

Now, you're right, the stock price was lower in Q2, we should have bought back more, but it's all against the available cash flow that we have in the United States.

And again, even looking out into the balance of the year, we've got the grid in place and we will buy back based on where the stock price is at any point in time.

We put the grid in place right after the trading window opens, and we'll try to do it as strategically as we can.

Thank you, Steve and Indra.

On this notion of pay out ratio of dividends where it stands today relative to your earnings or relative to your free cash flow, and then, you know, accepting the obviously lower level of taxation of dividends today for recipients of dividends, it seems that the Colgates, the P&G's, you know, this phenomenon we're observing is probably closer to the beginning than the end, and if you keep your current dividend policy as it is today, your gap is going to increase in terms of the percentage of your earnings or your free cash flow that you're giving out to shareholders.

So can you comment on how you feel about seeing that gap increase?

Well, Mark, we continuously look at this as everybody in the marketplace does.

I can only tell you this morning, we don't have a plan to change it.

But we obviously are conscious of that gap that you talk about, and we're conscious of other opportunities to use our cash, and we'll adjust as we think it's necessary to.

Indra, do you have anything to add?

No at this point of time, you know, our policy is to pay back one-third of prior year's earnings.

We had a nice increase in Q2, Mark, and that's one of the reasons we used some of the cash to pay extra dividends.

So I think, you know, at one-third of prior year's earnings, we are sort of in the ballpark of our peer companies.

Yeah, some of them are re-evaluating their dividend policies.

I think given our growth prospects in some of the acquisitions internationally in particular in our snack business, that we think might come about, I think it's prudent for us to hold our cash to make some of these strategic deals so we can really grow our business because the danger with increasing dividends is once you increase it, it's very hard to pull it back and say we're going to take it do down.

Sure.

Once you make the decision, it's got to be because you don't see too many other uses for cash.

So at this point, we don't want to lever up too much, so we are working all of these equations very strategically to make sure that we're doing what's right to secure the future growth rate of PepsiCo.

Fair enough.

Thank you, both of you.

Your next question comes from Marc Greenberg from Deutsche Bank.

Your line is open.

Good morning, and terrific results.

My question for Indra especially in light of your recent comment relates to thinking about incremental returns.

First I'd like to think about -- I'd like to ask about when you invest in things like Breakfast Squares, breakfast day part, how you reconcile that with the aforementioned strategic business opportunities internationally, because, you know, from the looks of things, especially through the pooling window, which will be next month, it looks like the opportunity set outside of that Quaker Foods business may be more attractive, and I just want to know how we should think about that.

Mark, Quaker Breakfast Squares is squarely within our snacking portfolio.

It's a convenient breakfast offering, and it's a wonderful way to extend our Quaker Oatmeal franchise and the investment in that business pales in comparison with what we would have to put out to make one of these international snack food acquisitions.

So hold that thought first.

Secondly, on international acquisitions, boy, we are waiting for one of those acquisitions to come about, Mark.

As you well know, we have the cash flow, we have the financial flexibility to go borrow some more money.

All that we want is one of those companies willing to sell to us.

So at this point, I don't believe we are cash or resource constrained to go off and do what we need to do to grow the business.

And again, as you and I well know, keeping within financial theory, as long as we have a nice positive spread to our cost of capital, we ought to be making those investments to secure the growth of PepsiCo.

And right now, all of the investments we are making in our businesses, whether it's Quaker Oatmeal Squares or international growth, are giving us an extremely positive spread versus our cost of capital.

So I think that's the right thing to do for PepsiCo to sustain our top line growth rate and our operating profit growth rate.

Thank you.

Your next question comes from Christine Farkas from Merrill Lynch.

Your line is open.

Thank you very much.

A quick follow-up on PBNA, specifically the growth in Gatorade.

Can you tell us where that came from?

Was it supermarkets or outside of that channel?

And secondly in Tropicana, how is the spread progressing between volume and revenue growth?

On the Gatorade front, we had growth across the board, a very, very strong quarter.

This is a very strong business, and we had significant growth in both measured channels as well as unmeasured channels.

If you'll recall, we're also now getting a contribution in some select channels from some very good performance from our bottling system.

So across the board, we had strength in Gatorade.

On Tropicana, we are in the middle of a significant change in pricing architecture.

It's work in progress.

It continues.

We are taking a significant amount of trade spend out and working to balance that against the volume implications, so we are making significant changes, and that is one of the key reasons you see the difference as we go forward between volume growth and revenue growth.

Great.

Thank you.

And if I can just follow up, Steve, you discussed efficient promotional spend versus a year ago alone in the Frito-Lay business would give you the difference between a 6 and 8% profit growth for that segment.

Should we be reading into this that your promotional spend will become even more efficient in the third quarter, or is this 6 to 8% supposed to indicate a range?

No, Christine, what I was talking about was the third quarter not the second quarter, and I'll leave it that.

As you remember last year, it was primarily a third quarter issue.

It affected us one out of the three periods in the second quarter, and all of the third quarter.

And so the improvement year over year will be affected mostly in the third quarter.

Great.

Thank you very much.

Your next question comes from Andrew Conway from Credit Suisse First Boston.

Your line is open, sir.

Could you talked a little bit about your 8% longer term operating income growth rate for Frito-Lay.

Could you just review where you see the revenue environment with that business too, or if there's been any subtle change to the volume price mix outlook given that you've become much more promotionally efficient?

And then secondly, I did have a question for Gary on Pepsi vanilla bundled with Pepsi Twist.

His perspective or consumer insight on whether Pepsi vanilla will build the equity of bringing Pepsi-Cola, as they work with their bottling system to get shelf space and put product out there, that the consumer makeup will be able to help the volume on core brand Pepsi?

Andrew, we're pretty pleased with the volume and revenue that we saw in the second quarter at Frito, so I would say we're -- that's pretty much where we want to be.

Great.

We're really excited and our bottling partners are very excited about Vanilla, and it's our Pepsi version of Vanilla, great product formulations which you'll taste shortly and very strong marketing to come, but a critical part as you mentioned is to help the overall trademark, and I think the best analogy is Live Wire on Mountain Dew.

We do intend to do some bundling.

We are recommitting to brand Pepsi.

We've got some pretty strong innovation in the works from a packaging and merchandising, even in the early stages of new advertising on brand Pepsi, and as I said, it all gets wrapped together with a very strong commitment and excitement from our bottlers.

Thank you.

Your next question comes from Bryan Spillane from Banc of America Securities.

Your line is open.

Good morning.

Just a question on bottled water for you, Steve.

As you look at the landscape, do you see -- and you kind of balance or you look at what type of investments you want to make with your cash flow going forward, have you looked at all at the bottled water category both in the U.S. and outside the U.S.?

And I guess also home office and delivery, where there's a lot of growth.

Is that attractive at this point relative to some of your other options and is it something you feel like you need to compete in?

Well, Brian, we are very happy with the Aquafina brand.

We think that building that brand equity is something that we're good at doing and we're very pleased with the progress that we're making in building that and the pricing that we've seen in Aquafina.

Moving outside of the products that we now serve is not something that we're actively looking at, and as far as home office delivery, it's not an area that we're actively looking at.

Just to follow up on home office and delivery, is that an area where your bottlers at all have looked at it or asked you to look at it at all, and do you think that's something in the future that might fit in there?

As an add-on for your bottlers?

I don't want to speak for the bottlers, but I would just say we're conscious of it, we watch it, but it's not something we're actively interested in at this point.

Thank you.

Your next question comes from Caroline Levy from UBS.

Your line is open.

Good afternoon, everybody.

Couple of questions.

Could you review with us, Indra, your acquisition criteria, perhaps financially what you look for and also strategically?

That would be really helpful.

I'd like to -- the second thing is I'd like to understand better why you wouldn't be willing to take on some debt to buy back stock.

You know, to take that greater than the $1.5 billion even, given how incredibly strong your balance sheet is.

In terms of acquisition criteria, let me have Mike White who's sitting here talk about his international acquisition criteria.

Mike?

Hello, Caroline.

In terms of from -- I'll talk from a strategic standpoint, let Indra address the financial standpoint, but clearly as we look around the world, international is 30% of PepsiCo sales and 20% of its profits, and as I look at kind of the opportunity for 95% of the world's population which is outside the United state, I think that's a fraction of where we can be.

Down the road as we look at it growing the international business.

Our first priority would clearly be strategic fit from a core salty snacking business standpoint, and there are a number of areas in the world central Europe, Asia in particular that I would say are priorities for us to continue looking at acquisitions in the salty snacking arena.

We also, from a beverage standpoint, are looking selectively at strengthening our business in a number of those areas.

Again, I would say probably strengthening our position in Europe and Asia, particularly China would be priorities from a beverage standpoint, but, you know, we want to stay within our core food and beverage kind of convenient food and beverage portfolio, but I'd say that's perhaps a little broader than purely salty snacks or CSD's as we've seen in the U.S., but, you know, those are the criteria, I'd say, from a strategy standpoint.

The other thing I would say is clearly I'm looking for leveraging to get to scale in a few countries rather than doing lots of small things.

Caroline, let me talk about the financial criteria.

When we go into any sort of an acquisition, one of the things we are very, very particular about once it meets the strategic criteria is that we don't overpay for the asset.

So we try to make sure that, you know, we pay a reasonable amount for the asset or, as we have to pay more than historical multiples, that we have extraordinary synergies to flow through to PepsiCo.

So by and large we try to do deals that are accretive to PepsiCo sort of in the second 12 months of the deal.

We'd like to be in the first 12 months, but if it's really strategic at least the second 12 months, it's got to be accretive to EPS.

We also try to look for deals that are helpful to PepsiCo from a top line growth, not just a cost synergy perspective because you know cost synergies as you well know run out in the first couple of years and you have to grow the business, so we try to make acquisitions that help our top line growth.

Having said that, we look at acquisitions on several buckets.

We look at acquisitions to fill in white spaces in our international markets.

We look for acquisitions that help us get scaled in international markets where we already have a business, or we look for acquisitions that help us fill a neat product line or technology gap that we have in our portfolio in the United States or internationally.

And we look at pretty much everything that comes along, but we reject more than we buy.

So that's the answer to your first question.

Indra, just one other comment.

I want to make sure everyone is clear on.

Our folks in international are very, very focused on driving our existing business right now, and I hope you saw that in the quarter's results, so, you know, while we're looking strategically always for opportunities to strengthen our portfolio, I don't want the balance to be confused.

We're very focused and continue to believe with our existing business we've got lots of growth opportunities.

In terms of levering up to buy back more shares, Caroline, of course we can lever up.

We have a very, very strong balance sheet, and we have absolutely terrific debt capacity.

But at this point, we thought it was prudent financial management to use available cash to buy back shares.

And I'll be honest with you;

I'm not sure the rating agencies look very favorably upon companies that lever up merely to buy back shares.

Having said that, as I said earlier, we are constantly re-looking at the capital structure, we are constantly re-looking at all our share buyback cash use strategies, and if at some point if the rating agencies change their mind and if we believe it's the prudent thing to do, we'll do that.

Thanks very much.

Your next question comes from Marc Cohen from Goldman Sachs.

Your line is open.

Ok.

Thanks, Hi.

This is a question for Mike, and to build on Mike's comment about really driving organic growth.

I wonder if you could talk a little bit, I believe -- is sort of the biggest operation in the whole international snack area and you do cite relatively flat performance there.

Mike, I wonder if you could sort of outline some of the challenges you're seeing at Sabritas and some of the strategies you're putting in place to dry try and drive that business back to the strong growth it's shown historically?

Sure, mark.

First of all, we have seen very solid performance out of Sabritas out of a local currency standpoint this year, so I want to make sure that things are in proper context given the weakness that we've had in the peso.

Our Sabritas business has been up in peso terms in double digits, so I think first of all let's keep that in mind.

Our margins are very healthy and solid vest us a year ago and in an absolute sense.

Sabritas is clearly an important business for us, and having said that, I certainly have been a bit disappointed in our kilo growth in that market, and having been down there a couple times, two or three times since I took over, I think we've got some new strategies that we are already putting in place that should enable us to see a significant improvement balance of year and particularly next year, and let me just comment on those.

First, we know that in bag promotions with kids is an important part of our marketing arsenal in international, and we've been a bit light on that up to this point this year.

We had some execution issues, and I don't think we had the kind of properties that we've had in the past like Pokemon.

I'm delighted to tell you right now, we've got a little in-bag disk called a Tazo that's made out of metal that is flying and doing very well.

In fact, into third quarter already, we're seeing positive growth in mid single digits in kilos out of Sabritas just based on that promotion alone.

The second component, I think, is innovation.

We've got some new products that are going in right now.

They're actually kind of taking an idea that we developed in Europe which was Lay's Mediterranean where we kind of tailored Lay's with flavors unique to the Mediterranean well.

We've going to taken the concept tailored to Mexico with Sabritas Mexicanas trying to really balance global and local pace in a way that

I think is the key to grab drive per capita consumption in the food business.

That's off to a flying start, again, just having been launched a couple weeks ago, is also contributing already to our portfolio.

And the third thing, Mark, I think, is that our value equation, we probably need to do a little bit of fine-tuning given the weakness in the economy down there, and be a bit sharper in terms of the value proposition that we offer consumers.

I don't think that would entail any wholesale major price reductions, but I think we need to be a bit more sharp with our kind of approach to value, and that you're going to see that with some very targeted weight-ups balance of year to put more value into some of our products, particularly those that appeal to C and D consumers.

So I think the combination of those three, we should see improved performance out of Sabritas balance of year, and I'm quite optimistic we've got some ideas that I'd rather not talk about today in terms of promotional properties that you'll hear more about in the weeks to come that are very exciting as well.

Thanks.

And the question for Gary, and you may have covered this in answering Brian's but maybe not.

I wonder, Gary, if you would talk about the relative merits as you see them of flanking Aquafina with a lower priced water entry, whether or not that is DSD-delivered or warehouse warehouse-delivered.

Talk about how you're looking at the pluses and minuses of doing that, because among the big three competitors, you know, -- you're in a unique position with only the DSD-delivered brands, mid-priced brands.

I'll let Gary answer that, but I wasn't sure whether I was clear enough, mark, in my comment.

We're very happy with where we are with Aquafina.

And that marc, I would reiterate that.

There are a lot of different models out there, and obviously we're very cognizant of what's happening out there, and we keep a watch, but as Steve said, we are very pleased with our current performance in Aquafina, and I'd also mention that we're extremely pleased with our performance on Propel, which is growing very, very strongly in the enhanced water category as well.

Okay.

Thanks.

Your next question comes from Carlos Laboy from Bear Stearns.

Your line is open.

Yes, Good morning, or Good afternoon actually.

I was hoping you could expand on the performance of walkers, the outlook for new products, and how the comps look there as we go forward.

Mike?

Sure.

Carlos, walkers is having a terrific year.

Our kilos are up high single digits.

That's driven in part by the addition of the what's it snack brand that we launched with a new formula earlier this year and also is performing extremely well.

In addition, Carlos, we've been trying to develop our own kind of European approach to convenience foods.

You know, kind of taking a little bit of a page out of the Al Bru and the Frito-Lay North Americas teams bouquet, but tailoring it to the U K and so what we've been doing and just little launched is a product calls walker's sensation vegetable crackers.

It is a product kind of that appeals in the U.K.

It's off to a terrific start.

Walker's sensations is a premium potato chip that we launched last year, did fabulously well in the U.K.

We're now trying to broaden that line.

We're looking at a couple of other product areas like pretzels and a few other areas but right now the initial kind of results from the vegetable cracker product are just terrific.

They're off the shelf.

It's a bit of a better for your idea, and we're excited about that.

Also, could you comment briefly on Brazil?

Things seem to be going pretty well there.

In terms of snacks?

In terms of beverages.

In terms of beverages?

Yeah, Pepsi twist, we launched Pepsi twist there with lemon juice in it, and I think that's been one of the keys.

It's a really differentiated product.

It's doing extremely well.

We obviously are very pleased in the partnership that we have with the (inaudible) team, they're doing a great job executing, and frankly on both snacks and beverages, I believe Brazil has got to be a big part of our future if we're going to realize our potential in international.

Thank you.

And our final question comes from John Fouche from J.P. Morgan.

Your line is open.

Good afternoon, everyone.

A question for Al.

It seems as though one of the focuses on the natural line as well as Stacks coming up is to gain distribution in other aisles of the store away from the core salty, traditional salty snack aisle, and then also for the natural line at least, gain distribution in alternative channels, particularly the natural foods channel.

Can you talk about how that's gone for natural and organic and then what that means potentially as you look to launch Stacks?

John, in both cases, it has gone exceptionally well.

The retailers have accepted these products.

We're expanding distribution continuously, and the retailers are eagerly awaiting our launch of snacks.

The space has been reserved and just we're counting down the hours.

So for Stacks you are having - having success in terms of putting that in the warehouse aisle next to Pringles?

I assume that's the plan?

Yes, sir.

And the natural and organic line?

And the natural and organic line, we're basically getting a space in the natural and organic section of the stores.

That's how we launched the product.

We're not putting that product in other aisles in most of the stores, we're going to the natural organic Section.

And we're also putting natural organics in the produce section of stores where it really goes well with the vegetables and things that are displayed in that area of stores.

Excellent.

Thanks.

Let me close by emphasizing again that we believe our businesses are on a very sound footing with great plans for the future and solid growth prospects.

Yes, there are challenges out there, both domestically and globally, both on the economic and the competitive front, but we believe we understand both the top and bottom line challenges, and we know what we need to do.

We have smart and experienced associates all over the world committed to continued growth of our businesses, and I have confidence that our people will do a great job executing our plans and achieving that growth.

And I thank you all for joining us today.