百事 (PEP) 2004 Q1 法說會逐字稿

Thank you everyone for joining us this morning.

This call is being webcast and can be accessed at our website, pepsico.com.

It is also being recorded and will be archived at our website for 90 days.

Our prepared remarks this morning will be made by Steve Reinemund, our Chairman and Chief Executive Officer, and Indra Nooyi, our President and Chief Financial Officer.

Steve will discuss the highlights for the quarter, and Indra will discuss several corporate items and discuss greater detail on the financials, including our balance of the year outlook.

Then we will open it up for your questions to Steve and Indra.

I would like to remind you that we intend to limit it to one question at a time so everyone has the opportunity to ask what is on their mind.

If you would like to ask a second question, please just get back in the queue.

And now it is my pleasure to introduce Steve Reinemund.

Good morning everyone, and I appreciate you joining us this morning.

It is a pleasure to be here to discuss our first quarter results and our outlook for 2004.

Since Indra previewed our first quarter results several weeks ago we are going to limit our prepared remarks this morning and get to your questions as quickly as we can.

Overall I have had to say that I'm very pleased with our business performance.

And I might remind you that during our last call I said that we ended 2003 with momentum and that that momentum carried into the first part of the year.

Well I'm happy to say that that momentum has continued and is continuing.

We often hear around here I'm sure and you do too the term, a perfect storm, when everything lines up to create a disaster.

Well the opposite was true for us in the first quarter, and we would like to say we had the perfect sunny day.

All the businesses in our portfolio performed well at the top line as well as the bottom line.

I would like to just give you a brief commentary on each of the businesses and then I will let Indra talk about the numbers.

First, Frito-Lay North America.

Frito delivered a solid quarter for the start of 2004.

The base business performance was excellent.

Innovation was above expectations delivering strong incremental growth.

And our productivity programs delivered on plan to sustain margin expansion.

The best example, I believe, of the health of the business is the performance behind the Lay's trademark in the first quarter.

Overall Lay's trademark grew 15 percent in revenue during the quarter, and it gained almost 3 share points; a great performance for our largest snack brand.

The most significant initiative within the Lay's family is the relaunch of Lay's Classic Potato Chips.

I know we have talked to you before about this program, but let me just remind you that we improved the product to deliver a more preferred chip that is lighter and crisper, and we upgraded the packaging which really pops as you walk down the aisle in your local store.

And we're celebrating this upgrade with TV advertising and promotion that focuses squarely on this quality improvement.

This program has delivered the best start in a long time in our base potato chips, and that momentum is continuing into the second quarter.

The latest trademark also gained strength from innovation as most significant driver of volume across all our new products during the first quarter was Lay's STAX.

STAX is a superior product when compared to our closest competitors, and we let the consumers know that with comparative advertising that clearly communicates the clear consumer preference for Lay's STAX.

So far the STAX rollout is meeting our expectations.

Consumer trial is on track and our depth of repeat is excellent.

So summarizing STAX I have to say it is off to a great start.

(indiscernible) Frito innovation is also clearly driving growth.

Doritos Rollitos is running ahead of our expectations.

Munchy Snack Mix continues on its roll, and it is the newest star within the Frito portfolio.

And the natural and organic line continues to deliver steady and solid growth.

And I might add that all of these products, including STAX, are helping us obtain additional retail shelf space that is so essential to driving incremental growth.

The balance of the year we plan to have additional innovation in Frito-Lay, with new better-for-you products like the Edge low-carb product which will come in Doritos, Tostitos and Cheetos, as well as Crunchy Baked!

Cheetos that broadens our baked line of products.

In addition we intend to take the lessons that we have learned on the Lay's restage and apply it to other big brands like Tostitos.

Now on the cost side Frito's productivity programs have helped offset the input inflation supporting the improvement in operating margins.

While we continue to be challenged with some input cost inflation, and Indra will talk a little bit more about that in a few minutes, most significantly this inflation has been in cooking oils.

And Frito's tight cost controls, combined with their productivity programs, is working to contain these costs within our P&L.

So overall Frito-Lay is off to a solid start in 2004.

Now let's turn to PepsiCo Beverages North America.

Obviously we're very pleased with our start in 2004 across our entire beverage portfolio.

The beverage team had a terrific quarter.

We continued to gain share in the total liquid refreshment beverage category in the U.S. in the measured channels.

And first I would like to talk about our CSD business where we grew 2 percent.

Our trademark Pepsi volume trends did improve in the first quarter as we had expected, with volume growing in the low single digits due to stepped-up focus on brand Pepsi, very strong growth in Diet Pepsi, and continued benefit from Pepsi Vanilla.

You all know our plan this year is to put more focus on Pepsi and leverage our new It's the Cola campaign.

And I have to say the results in the first quarter would indicate that this strategy is on target.

And the trends on trademark Dew were even stronger, growing in the mid single digits with growth on both diet as well as the regular segments.

Overall our total PepsiCo Diet CSD portfolio grew in low double digits, while the regular CSD portfolio was slightly down.

Lewis Lowes (ph), our bottling partners also benefited from the first quarter rollout of Tropicana Juice drinks.

And they are off to a great start.

This extension of Tropicana franchise to the bottling system, combined with the positive volume on Tropicana Chilled, delivered double-digit volume growth across the entire Tropicana trademark.

And for the chilled business segment the new Tropicana Essentials line was successfully launched in the first quarter.

This new line positions the chilled business segment for stronger growth for the balance of the year, as the marketing programs for this line of products is just is just beginning to kick in.

Tropicana Juice drinks is just the latest addition to our non-carb portfolio.

This new entry, combined with the continuing strength of Aquafina, Gatorade and Propel, drove over 13 percent growth in our non-carbon portfolio.

As you know we have great brands in each of these categories, and we're clearly advantaged versus our competition in the strength of our non-carb portfolio.

For example, Gatorade's momentum continued with another strong quarter with volumes up in the midteens.

The rollout of Gatorade X Factor and the strong off-season retailer support positions the business as we enter this key summer selling season in the second quarter.

Now in summary, PepsiCo Beverages North America just had a tremendous start in 2004.

Given somewhat stronger -- or tougher overlaps in the back half of the year, I don't expect double-digit top line results for the balance of the year.

We do, however, have strong marketing programs in place and will benefit from the relaunch of Mountain Dew LiveWire that is already in the marketplace, as well as the summer launch of Pepsi Edge.

Now to close out our discussion on North America, the results of Quaker Foods improved in the first quarter due to the volume growth from our breakfast businesses, largely oatmeal.

While Rice-A-Roni continues to be challenged, we are working on programs to address the current weakness in this category.

And finally let me just discuss PepsiCo International.

PepsiCo International had a spectacular quarter.

Overall snack volume growth was 10 percent and beverage volume growth was 13 percent.

The volume growth was pretty much across the board.

In snacks every region grew with double-digit growth in Asia-Pacific and the Europe and Middle East and Africa regions.

And the growth in the Latin America accelerated as macros improved in the key businesses like Sabritas, which got off to a great start by leveraging value in strong promotions like Obertos.

And beverage's growth was double-digit across all regions and just about all markets.

Net revenue growth of 19 percent was driven by volume and as well as favorable foreign exchange.

Now admittedly the foreign exchange benefit was unusually high, and that is due to the significant appreciation of the pound and the euro offsetting what was modest weakness in the Mexican peso.

Profits in International also benefited from currency, but even if you stripped out the foreign exchange, the profit growth was just outstanding.

So it is a great start in this business this year.

Now it is hard to point to any one or two key drivers of success.

Lots of things were working across the portfolio, and I look for this momentum to continue.

Now throughout the year we have significant innovation combined with strong marketing and promotional support.

For instance, in snacks the potato chip platform continues to drive growth as we roll out a series of initiatives that combine local flavors and cuisines of the local area with new technologies which leverage flavored and aromatic oils.

In some markets we are also using new oils, like olive oil, for more premium, better-for-you positioning.

And in the second quarter we have a number of potato chip relaunches in some of our biggest markets, including Mexico, Australia, as well as Brazil.

Now complementing Lay's product news is news on Doritos, to build the dipping occasion outside the United States and to leverage our proprietary inclusion technology.

Now we also have a promotional calendar which is full as we continue to use the Obertos property around the world.

Moving into Beverages we're introducing new consumer-friendly packaging like the new grip bottle.

And we're innovating with new flavors continuing to leverage our strong promotional platforms in music and soccer, as well as developing our non-carb portfolio in a disciplined manner.

Now key non-carb initiatives include expanding Propel in Mexico, extending our Lipton JV into China, introducing Gatorade into Japan which by the way is the largest isotonic market in the world after the U.S.

And across both snacks and beverage it is clear that our front-line capability has stepped-up both with the snack system as well as with our bottling partners.

In market after market we have stepped-up emphasis on execution behind Power of One promotions and customer activities.

There remains a lot of potential as we bring these businesses together.

But clearly our new integrated international business model is off to a very strong start.

Going forward it is unlikely that this level of foreign exchange favorability will remain throughout the year.

However, more important than that, the fundamentals of the business are well positioned to deliver a great year in 2004.

This is evidenced by the current business momentum, by the potential in our balance of the year programming across both snacks and beverages, and by a clear step up in front-line execution.

So to briefly sum up there are three things that are working across the entire business.

This is both inside the US as well as outside the US.

First, good innovation combined with big brand support, this is moving the business and the innovation is sticking.

Secondly, Power of One customer and channel strategies are having an increasing impact on our business.

And third, productivity efforts that are providing cover for cost inflation are contributing to margin expansion.

Well that concludes my prepared remarks.

Let me turn over the program to Indra who'll provide more details on the financials and a couple of corporate items.

And then we will talk to about your questions.

I will spend just a few minutes discussing the items below the division profit line of the P&L before we open it up to questions.

As you know we typically generate a point or two of leverage from some combination of corporate cost control, tax rate reduction and/or share repurchase leverage to generate EPS growth in excess of our division operating profit growth.

And our expectation for the full year is for this model to hold.

However, as you can see, in this quarter our EPS growth was actually a bit lower than our division profit growth sensibly because of the because of the increase in corporate unallocated costs.

Let me talk you through what is driving the increase, explain how these costs will flow through the quarters, and help set the expectations for the full year.

For the full year we expect corporate unallocated costs to increase roughly by about $100 million.

As we discussed with many of you at our December meeting and on the Q4 2003 call, this is driven by an increase in our pension expense of approximately $75 million, and by an increased investment in our business process transformation initiative of about $20 million.

Although the pension increase is fairly constant across the quarters this year, the BPT increase, or the Business Process Transformation Investment increase, will be felt almost entirely in the first half.

Remember, we kicked off this initiative in Q2 of last year, so the year-on-year spending increases are in the first half until we lap the full ramp up in the second half.

In addition, in the first quarter we took a charge to eliminate profit on inventory held by our equity bottlers in corporate unallocated, as is our policy.

This adjustment can be a charge or a credit in the quarter depending on bottle inventory levels, and the amount typically tends to be modest.

In this quarter it happened to be more significant due to inventory ordered by the bottlers in anticipation of the LiveWire relaunch.

Over the course of the year this adjustment tends to net itself out.

Finally, we made a modest donation to the PepsiCo Foundation in the quarter.

The bulk of our donation last year was made in the second half, so this is an item that has a negative impact in the first quarter, but will have a positive overlap in the second half.

Let me now comment on shares, which had a roughly neutral impact on corporate leverage in the quarter.

Our fully diluted share count is up slightly versus the first quarter of 2003, but down sequentially from Q4 of 2003.

With a stock strong year-to-date performance, the common stock equivalent calculation for our options is higher, with more options now in the money.

We also had a higher level of option exercises.

As you know, our Board authorized a renewal of our share repurchase program, allowing for $7 billion over three years.

We completed the previous $5 billion program this week.

We expect our total repurchases for this full year to be about $2.5 billion.

So to sum up, your takeaways of corporate leverage should be, one, base corporate G&A is down slightly in the quarter.

We expect $100 million increase in corporate unallocated for the full year, driven mostly by pension costs.

The Business Process Transformation increase of about $20 million for the year is front-end loaded mostly in the first half of the year.

There will be a positive overlap of donations to the PepsiCo Foundation in the second half.

Share leverages was neutral in the quarter driven by the strong stock price performance.

For the balance of the year and the full year, you should expect to see a return to positive corporate leverage.

Let me turn now to our cash flow performance for the quarter which we are very pleased with.

Operating cash flow, less net capital spending, increased from $122 million in Q1 of 2003 to $537 million in the first quarter of 2004.

This improvement is driven by the increase in operating profit and the timing in our capital spending.

For the full year we continue to anticipate our operating cash flow to be approximately $4.9 billion.

After net capital spending we anticipate our cash flow to approach $3.4 billion.

This number includes a pension funding of about $400 million dollars, which is consistent with our past guidance.

In the second quarter we will make a tax payment of about $760 million that is related to the audit settlement that we reached with the IRS last year.

When we reported this at our December meeting we anticipated making the payment in Q1, but instead we're making the payment in early Q2.

This payment is already in our full year cash flow plan, so it should be no cause for concern when you see it in the next quarter.

You also begin to see the higher dividend payment in next quarter's cash flow statement as a new policy will go into effect with the June dividend payment.

Let me now include with a few general comments on the health of the business and an update on current guidance.

As you can see from this morning's numbers, all our businesses are performing very well.

We carried the strong momentum from 2003 into this year.

Toplines are showing very healthy organic growth balanced across our core brands and successful innovations.

We're seeing positive price realization.

Our productivity programs are working, leaving room for both margin improvement and to make investments in the business.

Division profits grew 15.5 percent, and this growth included just 2 points of FX benefit.

We have successfully executed the restructuring actions we undertook at the end of last year.

And we've got strong alignment across the organization.

The fundamental business is very healthy, which gives me a great deal of confidence heading into the balance of the year.

Before I turn to guidance for the full year, I will address a question that is a lot on your minds, commodities cost inflation.

There is no question about it.

We are seeing inflation in the commodities market.

But the outlook on our commodities costs for the year is better than what you might infer from what you are seeing in the market.

Let me give you our outlook for the year.

And here I will be talking about the basket of our top 10 commodities which accounts for slightly over 80 percent of our total spend.

We expect our year-on-year costs for this basket of commodities to be roughly flat.

How we get there in this inflationary environment is a combination of hedging programs, working effectively with our strategic suppliers, and productivity on commodities usage.

However, as you look at the costs across the divisions you should expect to see a bit of cost pressure at Frito-Lay North America, principally because of all costs, but that should be more than offset by savings at Pepsi Beverages North America and internationally.

Looking out to 2005, we feel reasonably comfortable with our commodity cost outlook.

The key unknown is how the corn and soybean crops look for 2005, which we won't know until early this fall.

We continue to work on productivity and strategic sourcing initiatives and ideas to offset as much of the commodity cost inflation as possible.

Net net we feel pretty comfortable with the net cost outlook for 2005, and we will provide you more of an update this fall.

Now on to guidance.

Our first quarter with EPS of 46 cents turned out a bit better than we had anticipated.

It was a combination of strong businessman momentum, positive foreign exchange, and a shift of almost a penny of restructuring costs that we had anticipated would hit in the first quarter into the second quarter.

You should consider the timing of these restructuring costs as part of your second quarter estimates.

As I have said, the first quarter results certainly make us feel better about the full year.

But at this point, early in the year, we don't think it warrants any significant change to our existing guidance.

It does give us a high degree of confidence in hitting the high end of our previous guidance, which is 229.

Remember going forward our overlap, both in terms of the business and currency, get a bit tougher.

To the extent we have further upside we may look at judiciously accelerating some investments in new growth platforms, moving just a bit faster on some parts of our Business Transformation Initiative, or slowing through the upside.

The point is we would like to keep some flexibility.

All in all, we expect to have another good year in 2004 and are very happy with the strong start.

Now let me turn it back to Steve.

Now we're prepared to take your questions.

Instructed (OPERATOR INSTRUCTIONS).

Bill Pecoriello.

Morgan Stanley.

Good morning everybody.

A question on the Frito North America volume front.

Your reliance in the past two quarters on large-scale innovation on your biggest brands, do you think the high volume growth we saw for Lay's Classic is sustainable over the balance of '04, or is that growth rate more concentrated in the first quarter?

And then on STAX, it looked like maybe prices were adjusted down in March with a big step up in volume.

Was that (technical difficulty) one month promotion or do you plan to hold these new price points relative to Pringles for the balance of year?

Well, Bill, we really think that the Lay's brand momentum should carry through the year.

As you know, the overlaps are slightly higher in the second half of the year.

But we think the momentum is strong particularly going into the summer season, and we feel pretty good about that.

As far as STAX is concerned, we have a plan for the year in average pricing, which takes into consideration promotion pricing.

And we feel pretty good about that plan.

It has worked for us so far this year.

And we also are very -- I didn't mention this earlier -- but we're very optimistic about the continued decline in our costs for the product as we get more experience in it.

We now are slightly ahead of where we thought we would be at this point in terms of overall manufacturing costs.

So the economics of STAX we think are heading in the right direction.

And our share in STAX is very encouraging.

It is early, granted, but just in the measured channel alone we're running between 20 and 30 percent share of the market.

And that doesn't take into consideration, as you know, the Wal-Mart numbers.

Was that Tostitos relaunch that you mentioned also in the prepared comments, is that a fourth-quarter event?

It would be a second half.

We're still working on the exact timing on it, but we do plan on having it certainly for the third -- for the fourth quarter, yes.

And we're using, as I mentioned in my prepared remarks, we're using a lot of the same basic tactics that we used in Lay's for Tostitos.

And it will be the first major Tostitos relaunch that we've had ever.

Bill, if I may just add to what Steve said.

The thing to really remember is that Lay's is a family of products, because there is Lay's Classic which was relaunched;

Lay's Kettle Chips, which is also doing very well;

Lay's STAX and then Baked Lay's.

And you take that family as a whole, I think you will see strength across the entire portfolio.

And it is just taking the Mother brand and then launching products off of this that is creating the innovation and the growth.

Just to build on that a little bit more, and we think it is important to talk about it because it is our biggest brand.

As Indra said, there are a number of pieces of Lay's, and they play differently in different channels.

And for instance, the Kettle, which is growing at 75 percent year-over-year, really plays well in the up and down the street business, and there is some good lunch accompaniment in our foodservice businesses.

And we see continued opportunity for that -- the growth in that area.

And the large bag Lay's obviously plays well in the mass and supermarkets, and that business is in double digits.

So I think the balance of the Lay's portfolio is something that we feel has tremendous legs to continue growth.

Bonnie Herzog.

I guess I have a question this morning on your innovation strategy for all of your businesses.

I was hoping you could talk about how you look at innovation in general, meaning the mix between line extension and new capabilities, or possibly new platforms that we might see in the future?

Basically I'm trying to get an understanding of the possibility for what I might call break through innovation.

Or would it make more sense for PepsiCo to pursue acquisitions in an effort to expand its businesses into new areas?

I'm just curious how you look at this.

And then finally I would like to know how much of Frito Lay's volume growth during the quarter was generated from new products or line extensions, I guess, that have been introduced in the past year?

Do you want to take the innovation?

Yes, let me take the innovation question, Bonnie.

Last year we took innovation on as perhaps one of our major initiatives for this Company and dug deep into understanding how we do innovations, how we bring innovation to the market, and most importantly how we make innovations stick in the marketplace and get some meaningful price realizations through innovation.

And basically what we did is we relooked at how we classify innovation and the innovation processes.

Basically what we do is classify innovation so there are three sides, A, B and C. A, being line extensions.

B, being new products.

And C being brand new capabilities or brand new platforms.

And roughly speaking, what we would like to get to is some sort of a 60, 20, 20 mix of A, B and C innovations.

We're not there as yet, but that is our hope to get there.

What we have done is A and B types, which is line extensions and new products, are in the divisions.

The innovation type C, which is brand new platforms, we have augmented what the divisions are doing with investment from corporate in the area of new platforms.

So we have taken on a couple of new platforms, which I won't discuss today, to really see how we can invest in a C lab environment for future growth in the divisions.

So we're nurturing these new platforms.

So that is the way we're systematically looking at innovations.

We also did another thing last year, Bonnie, which is really trying to understand how to make innovations stick.

For example, if you go back to 2002 we had lots of innovations, but that since we didn't marry innovation and execution as well as we would like to marry it, in 2003 we undertook an exercise to really understand how to get innovation to stick on the shelf.

So we looked for new space in the stores so that we can actually go into new parts of the store and get consumers interested in shopping our products from there.

And we went to make sure that what we put in our core sections in the stores are married with how much incremental shelf space we get and how many spacings we get for these products.

So when we revamped our innovation processes, our innovation metrics, and married innovation to execution, what we're seeing more and more now is we have fewer new items going on in the marketplace, but they are sticking a lot more in the marketplace.

So the combination is giving us net incrementality and price realization that is pretty good.

Okay, and then do you feel comfortable about sharing with us how much of the volume growth we saw, or you saw in Frito-Lay this past quarter, was generated from what you might call innovation or new products or line extensions that were introduced in the past year?

Well, you know, Lay's Classic was relaunched as a lighter, crisper product.

That could be either just a relaunch of the old product or you could call it an innovation because we (indiscernible) the packaging and the product.

And that generated a tremendous amount of growth, as Steve talked about in his prepared remarks.

So the first quarter is a little bit difficult to say, but that is roughly what is happening in our business.

Just to put a little number on it, you could probably -- just the Lay's alone was 50 percent of the growth.

And if you take the rest of the innovation it is about half of that.

So it is a pretty substantial impact in the first quarter.

Andrew Conway.

Credit Suisse First Boston.

Good morning Stephen and Indra.

On the tremendous balance in Frito between core and also innovation, Steve, it is -- going back in time in your mind, has there been a time where you have seen as successful execution and balance as we have seen in this quarter?

And are there further learnings you can see from execution channel brand where you can see this move beyond your focus on Tostitos second half of the year?

Andrew, I think it has to be one of the best quarters that Frito has ever had, because as Indra talked about, with the Lay's -- the focus on Lay's -- here is the largest brand we have and we revitalized that brand in some basic ways of product reformulations, as well as more innovation with things like STAX.

And then we look at the rest of the portfolio and we had Rollitos, which basically is a rolled up Doritos, but has a very high appeal up and down the street -- was very successful.

The snack mix introductions, we have really gone from basically zero to a leadership position in snack mix within the last year and a half.

And that continues with introduction most recently of the children's version, which is fortified and recommended by Ken Cooper as a good-for-you product for kids.

So you go across the whole portfolio we really did have a very balanced portfolio.

And the key to innovation, as we all know, is the ability to stick.

And part of that, a large part of that, has to do with space.

And one of the things that Frito has done very well over the last year -- it wasn't just in the first quarter -- but they actually probably did it -- got the most benefit out the first quarter -- was they found new spaces in the store to take that innovation.

So for instance last year we talked about the natural line.

That natural line is a terrific line of products.

But most the most exciting thing about it is that it is merchandised in an incremental place in the store.

So the incredmentality of that product is excellent.

And we have done the same thing in the alternate snack aisle with products like Rollitos.

Snack Mix is sold both in the alternative aisle as well as in the main aisle.

So this whole idea of planning products by channel to get incremental space has worked quite well.

I don't think we have run the course on that.

And there is still more opportunity.

One of the big ones would be in the ethnic marketing area.

We think that the opportunity to bring products to market and specifically target the ethnic communities, and do it in incremental places in the store has huge upside.

And there are other similar kinds of analogies, but that will be the one that I would call out as probably the next big opportunity for us.

Great, Great.

And as a follow up to that, you've had superb productivity in the Frito organization.

As you move forward through the year if you could, Steve, at least frame a little bit how you see the margin performance, strong volumes, solid revenue per unit expansion, productivity?

You lack some of the trans fats, yet you do have the cost on corn oil.

How should we look at how you're managing the profit flow through and the successful tracking of managing the channels?

Andrew, I tell you, on a balance of the year the trend is approximately what it has been in the first quarter.

And that is the kind of topline growth and flow through that we're looking at.

As we get into Q4, it is there you see that we're not fully hedged on corn oil.

But I think we got enough productivity programs to even offset that.

So basically you should expect that for the full year we're looking at similar results for Frito-Lay North America.

Let me just add one anecdotal point, because I really think Frito deserves the credit for it.

They are tremendous execution organization.

And the energy costs are obviously a challenge for everybody.

One of the ways -- the primary way we are controlling energy cost is controlling usage.

So we expect actually energy to be flat the balance of the year, and is primarily going to be because of the way we're managing the usage of energy, along with smart buying and so forth.

But the ability to direct a disciplined organization like Frito in a way that can control costs as well as sell is really one of powers of that business.

Marc Greenburg.

Deutsche Bank.

My question relates to this strong operating profit leverage on the beverage side domestically.

I want to better understand the degree to which this is sustainable, especially since you've got 5 percent volume improvement and 20 percent profit growth.

Those are big numbers.

So I will ask it this way.

First, are there any timing issues around ad spend or promotion of new products that are going to even out?

I know Indra touched on the -- a little bit, but I don't think it was relating specifically to the divisional profit.

Second, how much of the first quarter profit comes from LiveWire in advance of the second quarter?

And third, is there anything happening to the core Trop business in terms of reduced promotional spend that might be driving margin expansion?

Let me take the Trop one, after Indra takes the other two.

Marc, clearly the first quarter flow through is not something you should count on for the whole year, as Steve mentioned in his opening remarks.

Let me just say that -- let me explain a bit how the flow through happened.

Basically as the business shifts from carbs to non-carbs we will see higher flow through because on a lot of the non-carbonated products we supply full goods to the distribution system.

And we get the revenue uptick and the profit flow through from the full goods.

So let me speed to those specifically.

In the first quarter, with Gatorade growing as well as it did, we got the benefit from that.

Second, we had a favorable packaging mix shift in Gatorade which also helped.

The third thing that helped us is the mix shift from regular Pepsi to Diet Pepsi.

As the mix shift from regular to diet, our revenue and profit flow through is higher in diet concentrate.

And the last benefit we got in the first quarter was the LiveWire shipments and the Tropicana Juice drinks concentrate that we shipped.

So a combination of that gave us tremendous revenue and profit flow through in the first quarter.

Now just keep one thing in mind on LiveWire.

While we had the LiveWire concentrate benefit in the beverage line, as I mentioned in the corporate unallocated mark, below the line we took an offset because the inventory that the bottlers ordered, if they had not gone into the bottling operation already, we had an offset especially for our -- only for our equity holders, or our anchor bottlers.

So that is the overall net benefit that Pepsi Beverages North America had.

Going forward for the balance of year clearly you're not going to see all of these benefits.

You'll see some, but you won't see things like the LiveWire or the Tropicana Juice concentrate buildup.

You'll still continue to see some benefits from the full goods, because we are seeing a continuous shift to non-carbs.

And then the regular to diet is a function of how regular Pepsi does and how Diet Pepsi growth continues to sustain itself.

And one minor point, Indra, you might just talk about why we take it at corporate instead of at the divisional.

Yes, (indiscernible) a good point, Steve.

Let me talk about why we take the profit on inventory adjustment at corporate.

The division basically ships the concentrate to the bottlers and it counts as part of their shipments and their profit.

Because we account for the equity income off the bottlers, the anchor bottlers, at corporate we believe the right accounting treatment is to look at the profit and inventory adjustment against the equity income at the corporate line.

And that is why we account for it at the corporate unallocated line.

And, Marc, on the Tropicana business we are cautiously optimistic about the progress that is being made in Tropicana.

There's no question that the juice category, the chilled juice category, is still under pressure.

We're outperforming the industry.

And we're outperforming the industry in large measure because of the innovation that we're bringing.

And that is in large part as a result of two things.

One, the Essentials line and then the other is the Carafe products that we're starting to roll out.

As a result we're really managing that business to get the momentum moving on the topline again.

We're not expecting dramatic improvements at the bottom line, although if it comes that's great.

What we really want to do is get that business moving again and reinvigorate the category with news.

And we think that we've got some really good introductions that, frankly, gave us some beginnings to the momentum in the first quarter, but we would expect that momentum to pick up in the balance of the year.

Thanks.

Just one quick follow up.

I'm hoping you can help me reconcile something that PVG said a couple of days ago.

They're talking about cost pressures a little bit differently than, I guess, Indra, the way you outlined it for PBNA.

Are they benefiting any differently in terms of the supplier procurement initiatives, or to a lesser extent, or might that be just more commodity specific?

I think it is commodity specific.

And also the difference between our products we make and the products they make.

It is commodity specific, Marc.

Caroline Levy.

UBS.

Good morning everybody.

I was wondering if you could (indiscernible) three to five years (indiscernible) international business and think about what is your biggest sources of revenue and profits might be?

Caroline, you're breaking up on us.

Could you repeat your question?

Can you hear me now?

We can hear you, but it is --.

Can you hear me now?

Yes.

Sorry about that.

I was wondering if you could step up three to five years, let's a five years, and look at international and think about what your big profit centers might be that might be different from today?

I'm assuming Mexico, the UK are the big profit drivers today internationally?

But with all the growth opportunity in China, if you could address China and India perhaps?

Indra, do you want to take this one?

Yes sure.

Clearly as you said, Caroline, the Mexico, the UK will continue to be big businesses for us and large profit contributors.

I think what we are seeing is in the medium-term, in the next two to three years, Continental Europe, including Eastern Europe, is coming up very nicely and the business is showing tremendous momentum as all of the efforts of the past few years in building the per caps both in snacks and beverages are all coming to fruition.

If you want us to think beyond the two or three years to five years, there's no question about it.

Let me speed to snacks first.

China, India, South America these are going to be big opportunities for us.

Our snacks business in India is exploding.

Our businesses all over Asia, from Australia to Thailand to the Philippines to China, are all growing well.

And we feel very good about the prospects for our businesses in the South Asia and the Asia Pacific Rim.

Latin America come, you know, as long as the economy stays stable, I think they will continue to be great businesses for PepsiCo, because there is a hell of a snacking habit in Latin America.

On the beverage side to side our deliberate strategy to invest judicially and really work with our bottling partners to improve execution is paying off across the board.

I think Mexico will continue to show steady improvement as that bottling operation improves, as John Cahill talked about in his presentation.

Our Brazilian business is looking good.

All of South America, the businesses are showing steady improvement.

The big stars in our beverage portfolio are clearly going to be China, India.

Because in China our beverage business is growing in the double digits, and we're seeing tremendous improvement even in profits.

And India is going to be a slower profit picture, but I think as the topline continues to grow we will start seeing profits being generated from India.

So five years from now I don't think the portfolio will entirely shift away from Mexico and the UK and the continent, but I think you're going to see China and India being much larger contributors to the overall portfolio and the beginning of what we would like to call a balanced international portfolio, both between snacks and beverages and between the geographies of the world.

That's tremendously helpful.

I also just -- if I may ask for an update on how your new customer team efforts are working, particularly with very senior people leading Power of One?

Well, I would say a large part of our success in the first quarter in the topline, particularly in the United States, although I would say it is building momentum rapidly outside the United States, that this Power of One going to customers together as one business is paying big dividends.

And our largest U.S. customers where we have those Power of One teams, our growth rate is between 1 and 2 points higher than where we don't have Power of One teams.

Jeff Kanter.

Prudential securities.

Good morning everybody.

Indra, did you say that operating cash flow for '04 of 4.9 billion includes the 760 million tax payment to the IRS?

Yes.

The 4.9 billion is operating cash flow, then we have net capital spending.

So the total cash flow would be 3.4 billion.

That includes pension findings of about 400 million and the $760 million tax payment.

Fine.

What was the contribution to the foundation in the quarter relative to last quarter?

Jeff, we don't disclose that in that level of detail.

Fair enough.

Would you disclose though the bottler inventory charge at all?

No.

I mean these are all a bunch of corporate adjustments that we make below the line.

Fair enough.

Steve, it just seems that international is kind of hitting its stride.

When you look at the topline growth and the operating income growth is most of the growth coming from your established markets, or is it coming from new markets or a combination of the two?

It just seems like your at an inflection point here.

I was hopeful that you could comment a little bit.

You know Indra covered a fair amount of it as she talked about the future.

But I would just say that one of the things that made the first quarter so encouraging was that we saw growth everywhere.

And I could pick anecdotal examples.

You know the snacks in India was tremendous.

And we didn't talk about it -- we didn't talk about it recently -- but the scale model in our snacks business, because we build businesses individually by country and they are vertically integrated, when they reached a certain scale the profitability flow through just starts to move up dramatically.

And we have a pretty sophisticated model that tells us what it should be based on different volumes.

And as we reach that in different places it really starts to change the equation.

And we're starting to see that in countries where we have invested for a number of years.

So the encouraging thing is that this business appears to have, as we have always thought, universal acceptance from the consumer's perspective.

So that is good.

The second thing is, as we talked about it in the previous call when we talked about the reorganization, the real reason to reorganize the business was that we really felt working together we had scale in countries where individually we may not have the clout to go in and talk to what is now a large and consolidating retail trade.

And that has made a huge difference.

And we also have seven regions led by very experienced PepsiCo leaders who know -- in most cases have experience on both sides of the business.

And that has had tremendous upsides.

So we really think that the investments that PepsiCo has made for the last 20 years in the international business is now coming to fruition as we take the leadership that we have developed and put it to the consumer with the products and processes that we know how to do, and to build distribution systems that we think are advantaged.

So you put all that together and we feel pretty bullish about it.

But we are also mindful of getting out ahead of our headlights in terms of internal growth.

And we want to do this in an aggressive but planful way that allows us to have sustained growth over a long period of time, and we feel pretty good about it.

And also are the margins in these scale markets comparable to the overall corporate average or so?

It varies by business, but if you look at snacks the model for our businesses are based on the model that is developed for Walkers, Sabritas in the U.S.

And in our bottling business the economics are obviously different.

The scale differences aren't as dramatic as they are in snacks.

Steve, just listening to you talk about the seven regions I wanted to go back to something Caroline asked.

And I did not mention the Middle East as a region.

And that is a region which has been enormously successful for us, both on the beverage side, and now increasingly on the snack side.

I think Pepsi is as much a local drink as it is anything else in the Middle East.

And so I think both of us, I'm sure, are extremely proud of the performance of our business in the Middle East.

And I think, Indra, to your point that the thing that makes it so important for us as we develop internationally, we have great brands, but more importantly than brands we have local leadership that is experienced in our business and in our processes that can actually regionalize these products and make them relevant.

And certainly we have done that the Middle East.

And that is probably a place where the biggest benefit right now would be to be local.

But we see that everywhere.

That benefit of having the institutional knowledge, the corporate models, the powerful brands with the ability and leadership to adapt them to the local marketplace is really why we think it is going to work.

Because in the end, retailing is still an art and it is a local art, and it is one that needs to be practiced on an individual basis.

And we really believe we have the leadership talent around the world to do that.

Mark Swartzberg.

Legg Mason.

Steve, I think a follow up to the last little discussion you were having.

I wonder if you could give us your take on the retail environment broadly here, particularly in United States versus how you might have viewed it a year or two ago?

And Mexico is obviously quite a different market, but I would be curious how you're looking at the retail environment there today versus a couple of years ago?

I think the retail market in the U.S. is really becoming very distinct in the channels.

And you know the mass market, the mass marketing -- you know -- the Targets, the Wal-Marts, the Kmarts, very specific niche.

The dollar channel is becoming a very large fast-growing and specific niche.

The drug channel is becoming a very specific niche.

And we have always had up and down the street, but even in up and down the street we've gotten out of the organized trade, which is becoming a much more influential piece of that.

So there are -- there is really becoming a definition among these channels as to what they are and what they do for the consumer, which is clearly giving us an opportunity to develop products specifically for those consumer needs.

So increasingly as we take a brand like we talked about earlier, take Lay's, we can take that Lay's brand and take it in different places with different consumer needs, either packaging or product, and really leverage it.

So we think that the opportunity is really there.

There is a lot said about the consolidation.

Certainly that is happening.

It is happening primarily in the supermarket side of the business.

But I think we're starting to see the supermarket trade come out some of the challenges they have been in the last couple of years, not to say it is over.

But we're seeing some strengthening of those businesses, both for us and for the business in general.

So I am optimistic that a lot of the shakeout that we have seen in specific pieces in the retail trade is maybe behind us.

But retail is always going to be changing.

The consumers force that change, and there are entrepreneurs out there ready to take advantage of it.

But I don't think we will see as much rapid change as we have maybe in the last ten years in the next ten years.

Great.

And could you address Mexico?

Any noteworthy deltas there in your mind over the last couple of years?

No, I think Mexico is slowly evolving.

They still have a huge unorganized trade up and down the street.

Trade which I don't see going away.

However, the large organized trade, driven in large part by Wal-Mart, is certainly happening.

It is real.

When you walk through the supermarkets in Mexico today they are different than they were five years ago.

And Wal-Mart has had a lot to do with that.

But even with that said, the average shopping basket is smaller in those Wal-Marts.

So it gives the large format people a little bit of a challenge because they've got big square footage coverage, cost to cover, and the average shopping cart is still relatively small in U.S. standards.

So it is evolving but it is not evolving anywhere near the rate that we have evolved in the U.S. in the last ten years, at least not in my opinion.

And lastly, if I could, on Mexico, Steve, how about the consumer, it seems like we're seeing some signs -- a little more health there but from where you sit, how do you view it in Mexico?

That is how we would view it.

I wouldn't say it is dramatic.

I would say it is slight.

Our consumer is very sensitive to the economic conditions.

And so we see it slight increase, slight improvement which we think is probably indicative of what is going on in the economy.

And you know clearly the Sabritas business in the first quarter was no indication of the Mexican economy, at least nothing that I have seen would indicate that it is growing anywhere like what we did in the first quarter with Sabritas.

But Sabritas numbers were driven by excellent innovation and a very strong promotion.

Great.

Thank you.

Kristine Farkess (ph)

Merrill Lynch.

I just want to make sure I understand something correctly.

The lower option expenses in the quarter appears to have boosted your profit growth by about 2 percent across all segments.

If you could clarify or confirm that?

And my real question has to do with Frito-Lay.

You talked about a similar trend at Frito-Lay in the remaining quarters of the year.

Given -- in this light can you about the immediate consumption channel by your DSD system?

I think that in the first quarter of last year there were some weak trends there which hurt overall revenue per volume growth.

Will this become tougher as the year progresses?

Thank you.

Let me talk about the immediate consumption.

There are several aspects of immediate consumption.

There is the up and down the street business and that's clearly been strengthening for some time and it was -- you know, it continued that strengthening in the first quarter.

Then there is the vend side of the business, the vend and foodservice side.

That is driven the large part by the business environment, because that's where many of the vending machines are.

That is slowly picking up and we're encouraged by the positive movement that we're seeing there.

So overall it is incrementally better.

And we think it will continue at that rate for the balance of the year.

On the question on stock option costs, Bonnie -- I'm sorry, this is Kristine Farkess.

We have shifted from stock option based compensation to a combination of restricted stock and some premium bonus for high performance.

So we have got a different mix of compensation in our compensation plan.

But net net the impact is about 2 points in the first quarter, you're right.

Great.

And Indra, if I can follow up with respect to overall costs.

Certainly at PBNA the profit growth was very, very strong.

At the same time, it looks like there is increased to support behind brand Pepsi and maybe other brands.

Can you quantify the incremental marketing spend in PBNA or perhaps across the broader Company?

The SG&A line was up and I'm wondering how much of that is due to increased marketing?

We don't get into that level of detail, Kristine.

Robert Vanbruek (ph).

Sanford Bernstein.

Good morning.

I had a question about Sierra Mist.

Your starting to lap the introduction of the full national roll out now.

How is it performing?

Do you feel it is holding up?

A great question, Robert, and we're very enthusiastic about Sierra Mist -- have been and continue to be.

And the first quarter was really an inflection point because that was obviously the roll out last year.

We had an enormous support by the bottlers to introduce that in the marketplace.

And we expected that in our first quarter that the volume would be under pressure because of the load in factor from last year.

And in fact in the first quarter -- in the first period -- our first period -- it was down, not as much as we thought it would be.

But I would say coming out of the quarter and the numbers that you see in the March numbers you will see that, in fact, we're now running on a positive trend over a year ago.

And we expect to finish the year with Sierra Mist running in growth numbers higher than the category by a healthy margin.

But clearly this is not a product line extension.

This is a new brand.

And we're going to continue to support it, like we did last year and like we have been this year.

And we think it is a terrific product.

It proves to be a consumer favorite on a blind taste test.

And the advertising has been, in my nonobjective opinion, the best out there.

And it has really created created a sensation among the consumers.

And we are very -- we think it is right -- it was the right time to come out with it because clearly the consumer is looking at that type of a product as a wider type of alternative.

So we're very, very optimistic about Sierra Mist.

And we think the first quarter performance gives us the reason to be -- continue to be optimistic.

Bryan Spillane.

It is Banc of America Securities.

Steve, just two questions regarding commodities.

And you're seeing commodity pressures on a lot of key companies and there has certainly been -- you are starting to see that reflected in supermarkets.

And historically food companies have been able to pass pricing along, maybe a little been higher than the commodity costs and take a little bit margin.

And so I was curious to hear if you think there's an opportunity for yourselves and really for other companies to raise prices and maybe take a little bit of margin?

And then following up on that is also you guys are offsetting commodity costs pretty well.

And I imagine that your competitors, especially potato chips, aren't.

So I was just curious to hear if there's some sort of competitive advantage that you're seeing right now, given your ability to manage those costs maybe a little better than your competitors?

Well, Bryan, we're not immune to price increases, and we watch that very carefully.

But what we're trying to do, and have been for many years, we're trying to balance the topline growth with the bottom line growth.

And we certainly don't want to take what might be a short-term opportunity at the bottom line to jeopardize the momentum of our business.

So we watch that very carefully, and it is really more of an art than a science.

And clearly because of our size we have the opportunity to buy well, and we obviously you use that opportunity every chance we can.

And we do think that we have buying advantage, and we expect that to continue.

And I think we have proven that -- and this is a generality -- but I think we have proven that in price increases.

In a market where there are price increases our advantage versus the competition is probably even more significant than when there is price decreases in the market.

Because of our size we have to buy long in many situations, and that helps us on the way up, and doesn't help us as much on the way down.

So if I just would take your question and adapt that answer around it, I think you can probably get your own answer as to the advantage we have in the marketplace.

John Faucher.

J.P. Morgan.

I'm all set, thanks.

Eric Katzman.

It's Deutsche Bank.

I guess there are some specific cash flow questions.

Indra, on page 69 of the annual report you noted that operating loss carryforwards totaled 3.5 billion.

If I take that on its face, it is about 3 to 4 percent of the value of the Company.

But obviously there is a present value to that carryforward.

Can you gives us a sense as to what present value that 3.5 billion has?

And then the second question was last year deferred taxes were a pretty significant negative cash component of about 500 million.

And in the first quarter it continued to be a negative source.

And I'm wondering with your tax rate declining year-over-year and pension contributions increasing, why shouldn't deferred taxes be a benefit to cash?

Matt McKenna, our Senior Vice President of Tax, is right here to answer those questions for you.

So let me turn it over to Matt.

On the net operating losses those are primarily for state tax purposes and foreign tax purposes and not for federal income tax purposes.

The present value of those losses will depend upon the mix of income in those areas, and so it would be speculative at this point to project forward exactly when we're going to be able to generate the sufficient income to use those losses in those jurisdictions.

They're not federal income taxes.

On the deferred tax side, I think the simple answer is they will become a cash benefit at some point in the future.

It is just premature at this time to reflect them at this point, that cash benefit.

So in the 4. -- I think it was 9 billion in operating cash flow, does that include contribution from deferred taxes, or is that not part of your equation?

It reflects this year's benefit of the deferred tax taxes, but only this year's benefit.

This concludes the question-and-answer session of today's conference.

I would now like to turn the call back over to Jack Callahan for closing remarks.

Well thank you all for joining us this morning.

We're sorry we ran over about ten minutes, but we wanted to take all of your questions.

And just in closing I would tell you that I think you probably gathered from the tone of our conversation today that we are quite pleased with the first quarter's performance, and we're optimistic about the balance of the year.

And we appreciate your continued interest in our business.

Thank you and have a great day.