百事 (PEP) 2004 Q2 法說會逐字稿

[Inaudible] -- only until the question and answer session.

Today's call is also being recorded.

Please note the Company's cautionary statements.

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 and 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 the specific risks that may affect our performance.

To refer to the investor section of PepsiCo's web site at www.pepsico.com to find disclosure and reconciliation of non-GAAP financial measures used by management when discussing PepsiCo's financial results with investors and analysts.

I would now like to turn the call over to Mr. Jack Callahan, Senior Vice President of Investor Relations.

Sir, you may begin.

Thank you, Operator.

Welcome to PepsiCo's second quarter conference call.

Thank you for joining us this morning.

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

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

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

Once we open it up for your questions later in the call, Steve and Indra will be joined by [Dawn Hudson], President of PepsiCola North America.

I would like to remind you that we intend to limit the Q&A to one question at a time.

And now, let me turn the call over to Steve.

Thanks, Jack and good morning.

Thank you all for joining us this morning and it's a pleasure to be here to provide you with an update on PepsiCo.

I think in many ways our second quarter results are very similar to what we've delivered over the past several quarters, and I believe our overall portfolio performance was excellent, with 8% revenue growth, 11% division operating profit growth, and 12% growth in earnings per share with strong cash generation.

The quarter represented strong volume, good price realization, and quality earnings.

And globally, worldwide servings of beverages grew 10%, and worldwide snacks grew 6%.

Our international businesses and our North American beverage businesses continue to demonstrate very strong momentum.

And obviously, the performance of the Quaker snacks piece of Frito-Lay was disappointing, and this impacted Frito-Lay for the quarter and it overshadowed the solid, salty volume.

However, I might point out that it's one quarter's performance within a worldwide business portfolio that's performing very well.

Overall, now that we're halfway through 2004, I'm pleased with our business performance and looking forward, I'm confident that PepsiCo is on track to do at least 229 in earnings per share for the full year.

So all in all, 2004 looks to be another good year as a powerful PepsiCo portfolio continues to deliver.

Now, in a few minutes, Indra will review the performance across our divisions and provide a bit more detail in our total PepsiCo numbers, but I thought I'd just take a few minutes to share a couple of general observations about our business and the environment that we're operating in.

First, the retail environment is rapidly evolving, especially in North America, and is providing new opportunities and challenges.

Secondly, rising input costs are a reality and we find the -- as we find the right way to balance both price realization with the elasticity of our categories.

Third, the consumer is focusing more than ever on health and wellness and within this overall trend, there will be a series of fads.

But it's very clear that health and wellness is a big opportunity for growth for PepsiCo.

And fourth, PepsiCo is perfectly positioned to expand our portfolio of products around the world.

Let me just dive in a little deeper on each one of these items.

First, let me speak about the evolving retail trade.

Every day we're managing through new opportunities with our customers, as you understand, and all of our customers are consistently looking for ways to differentiate themselves with tailored programming, attractive pricing, and unique product offerings.

The overall North American retail market represents low single-digit growth, as you know, but some customers, like Wal-Mart and the Dollar Channel and others, are growing much faster, while there are customers that are really struggling.

And you can see these trends in the syndicated information that many of you use in your analysis.

Since the syndicated sources tend to track customers with relatively slower growth, the gap between the syndicated sources and our actual results can be significant, and that gap is likely to increase.

It may get harder for you to predict our results than it has been in the past, but it's also a challenge for us to flawlessly manage this ongoing customer evolution.

It's very clear that the customer landscape will continue to evolve over the coming years and PepsiCo must evolve its capabilities appropriately.

So far we're very pleased with the changes that we've made over the past few years to establish customer teams and to align all of the PepsiCo businesses behind one senior leader in these key accounts.

Going forward, we're going to strengthen these teams and provide them with even more tools to customize our strategies with our retail partners' strategies.

Secondly, we need to closely manage our ways through the environment of rising input costs.

And we began to feel this pressure last year when Frito-Lay made the strategic move away from cheaper cooking oils to more expensive, transfat-free oils.

But since then, the rising costs of raw materials and other input costs, like energy, have become an industry-wide issue and you've heard this before.

So far we have maintained good price realization across our businesses and will continue to look for tactical pricing actions over the near-term.

The challenge will be to balance these pricing actions with the elasticity of our categories to sustain solid volume growth.

The third observation I'd make that there is a clear underlying trend toward better health and nutrition.

Diet fads will come and go, and perhaps the peak of the Atkins fad is behind us, but it's clear that consumers want healthier product choices, but they also want great taste and they always want good value.

And it's our strategy to broaden our better-for-you and good-for-you portfolio with about half of our projects in our innovation pipeline across both snacks and beverages focused in this area.

Health and wellness innovation is a great opportunity, and it should help us sustain both growth as well as price realization.

Lastly, I want to discuss PepsiCo's global footprint.

PepsiCo International had another spectacular quarter as both the snacks and beverage business had double-digit volume growth for the second consecutive quarter.

With momentum now continuing into the third quarter, International is on track to have just a great year in 2004.

Now, perhaps the most frequently-asked question that we hear from you and other investors is about International, and the question is, how sustainable is the growth?

Well, there are a number of specific developments that give me confidence that our International business is entering its next phase of development and that we're well-positioned to sustain relatively higher growth for some time into the future.

Now overall, International is PepsiCo's major growth opportunity, and we're quite confident that our International business can grow at least twice as fast as our North American businesses.

But it all starts with a foundation of very talented and experienced people all around the world.

Well over half of our middle and senior management within PepsiCo are focused on our International businesses, and they collectively have vast experience in the industry as well as with PepsiCo.

Secondly, we have a great platform of products, brands and business systems that play well around the world.

Third, our growth is broad-based, geographically.

All regions are delivering strong growth and that should continue into the future.

Fourth, we're reaching scale platforms in countries all around the world, and that has a huge impact on our ability to drive the top and bottom line.

Fifth, we're making progress in unlocking the keys to increasing per-capita consumption on a market-by-market basis in both snacks and beverages.

And finally, our new international business model that integrates snacks and beverages is off to a very strong start.

But we feel we've just begun to see the potential.

We have many new, creative Power of One strategies on promotions, customer programs, productivity and development of talent.

And together we're building a much stronger capability within each market that we're in, adding to our scale and our overall competitiveness.

Well, that concludes my introductory remarks and in closing, the PepsiCo portfolio is clearly working.

And furthermore, we're well positioned to strengthen this portfolio by winning with our retail customers, maintaining balance, price realization, broadening our health and wellness product lines, and extending PepsiCo's global footprint.

Now, let me turn the call over to Indra, who will review the division performance and provide a few more details on our financials.

Indra?

Thanks, Steve.

Let me begin with freedom in North America.

Volume grew slightly less than 2% and revenue grew 4%.

The single biggest issue was the weak performance of the Quaker snack business that sold through the warehouse selling system.

Normally, we do not spend a lot of time talking about this piece of the Frito-Lay business since it's less than 5% the division sales.

But in the second quarter, the top line for this business was down approximately 20% versus year ago, with profits just about cut in half.

There are a number of reasons behind this performance.

First, Crisp 'ums and Toastables, new products introduced in 2003, are not meeting expectations and the current results compare unfavorably to the year-ago introductory volumes.

Second, Quaker light snacks, like some of our other better-for-you products like Rold Gold, appear to be negatively impacted by the low carb dieting trend.

Third, the Quaker bar business was down in the quarter, in part due to the step-up in competitive activity across the bar category.

Going forward, we do not anticipate that the Quaker business will continue to be such a drag on Frito-Lay results, in part due to the more management overlaps and balance of innovation that's outlined in the earnings release.

Over the last month, the trends in the business have improved somewhat, as the business is now running almost flat to year-ago.

The performance of the remaining 95% of Frito-Lay North America, largely the core, salty business sold through the DSD selling system, was better than the overall division results by about a point of growth in the top line and two points on the bottom line.

Importantly, Frito-Lay gained close to a point of salty market share in measured channels, and the salty price mix realization was excellent.

Innovation in Lay'sTags and Doritos Rollitos, new marketing on our market packs, and the continuing success of Tostitos and dips and classic Lay's all drove the growth.

While Frito-Lay's second quarter salty snack was solid, the growth rate was not quite as robust as the first quarter.

Dollar growth for classic Lay's, the division's biggest brand, decelerated from low double digits for the US retail business in the first quarter to mid-single digits in the second quarter, in part due to significantly stronger media support in the first quarter.

Stax continued to be a growth driver in the quarter, but there was significant competitive activity around Memorial Day.

In the first quarter, we also had great success around the key holiday: Super Bowl.

In contrast, Memorial Day, which is a key holiday of the second quarter, was not quite as strong.

All in all, a solid quarter for the salty business, but not quite like the fast [inaudible] results posted in the first quarter.

Salty snacks also continued to be impacted by raw material inflation; largely cooking oil, and to a lesser degree energy.

The combination of cost productivity and good, salty price mix realization so far this year has helped limit the impact and margins continue to expand.

As Steve discussed earlier, Frito-Lay will balance tactical pricing, closely watching category elasticity to maintain healthy price realization and solid volume growth.

Overall, our salty snack growth remains solid and we have strong balance of year innovation and programming planned as outlined in the release.

Frito-Lay's trends should improve compared to second quarter performance, as the salty business continues to deliver and the overlap on the Quaker snacks delivered to the warehouse improves.

Now let me turn to PepsiCo Beverages North America.

Obviously, we are very pleased with the North American beverage team's performance in the second quarter.

Our volume was up 7%, revenues were up 9, profits were up 12%, and PepsiCo continued to gain share in the total liquid refreshment beverage category in the United States measured channels.

First, let me talk about our CSD business, where our volume grew almost 4%.

You all know that our plan this year is to put more focus on trademark Pepsi, and the results the second quarter indicate that we're very much on-track with the strategy, with trademark Pepsi growth in the mid-single digits.

The growth of Sierra Mist was even better, in high single digits, as we, along with our bottling partners, continued to build this new platform on top of the strong introductory results posted a year ago.

Our share of the lemon lime category was up 1.4 points this quarter.

And we have CSD product innovation planned for the balance of the year.

Pepsi Edge, our mid-calorie cola, was launched last month and should continue to drive Pepsi trademark momentum.

In addition, another limited time only offering, Mountain Dew Pitch Black, timed to the Halloween holiday, will bring fun and relevant innovation to the category.

I also want to highlight the incredibly strong, 14% growth that we deliver across our market-leading non-carbonated beverage portfolio.

Gatorade, Aquafina, and Propel all had double-digit volume growth.

In addition, we, as well as our bottling partners, continue to benefit from the addition of Tropicana fruit drinks, which is clearly driving incremental growth.

And the chilled Tropicana business did deliver positive volume in the quarter, in part due to the new Tropicana Essentials line, which includes Tropicana Pure Premium Light and Healthy, now with 50% less sugar and calories than regular Pure Premium.

Overall, we have the best, most advantaged portfolio of non-carb beverages in North America and these results clearly demonstrate the PepsiCo advantage.

In summary, Pepsi Beverages North America had a great first half 2004, and we have strong marketing programs as outlined in the earnings release.

However, given somewhat tougher overlaps in the back half of the year, it may be harder to pull such outstanding numbers for the balance of 2004.

Going forward, the third quarter, in particular, has two negative impacts due to holiday timing.

The second quarter of volume growth was boosted a bit by the timing of Memorial Day this year, since the post holiday's slow week impacts the third quarter in 2004 compared to the second quarter a year ago.

In addition, the benefit of Labor Day loading will shift into the fourth quarter, due to a later holiday this year versus last.

Turning now to PepsiCo International.

As Steve said, PepsiCo International had another spectacular quarter as both the snacks and beverage businesses had double-digit volume growth for the second consecutive quarter.

Snacks grew 11% and beverages grew 13% in volume.

Both momentum now continuing into the third quarter, International is on track to have just a great 2004.

To reiterate Steve's earlier comments, we are confident that International can sustainably deliver this growth for some time to come.

Our geographic reach is strengthening; more specifically, growth in Latin America is accelerating as macros improve.

The Europe, Middle East and Africa regions continue to deliver balanced beverage and snacks growth, and the vital Asia Pacific region is consistently delivering high, top-line growth and sustained margin improvement.

Our portfolio is becoming more balanced, with our mid-size businesses led by Brazil, China, India, Russia, Turkey and the Middle East, all making bigger contributions.

And relevant, localized innovation based on deep, consumer insight is driving per-capita consumption.

Lastly, Power of One will have an increasing impact on promotions, customer programs, productivity, and the development of talent.

All of this has contributed to a great quarter for International, and promises to keep the strength going for some time to come.

That concludes my comments on division performance.

Now I'll spend just a minute on a couple of items below the division profit line and the P&L, and then turn to cash flow before we open it up for questions.

Corporate unallocated expenses increased by approximately 35 million in quarter 2 over last year, driven by increased pension costs, investment in our business process transformation initiative, and a negative net [forex rate] versus last year.

As I said on the Q1 call, for the full year, we expect corporate unallocated costs to increase by approximately $100 million, driven by increased pension costs of $75 million and incremental business process transformation investments of $20 million.

Year-to-date, corporate costs are up 91 million, but the back half comparison will be more favorable.

In the third quarter, we expect corporate cost to be up $35 million and in the fourth quarter, you should see a $25 million benefit year-on-year.

Timing on some of these costs is tough to predict, but this is how I'd model out the second half.

Let me now comment on shares outstanding, because as I looked at some of your models over the past few weeks, this is where I see the most inconsistency.

In most cases, what I'm seeing is that the models have underestimated our average, diluted share count.

We have attached a schedule to this morning's release that I hope clears this up.

It's Schedule A-5.

I'm not going to go to the schedule in detail, but as you look at it, you will see that our basic shares outstanding have been decreasing as shared buybacks more than offset shares issued in option exercises.

And the total number of stock options outstanding has also declined.

What has increased is the impact of dilutive securities caused by the outstanding stock options, and this is entirely a function of the appreciation in our share price, which causes the options to be deeper in the money.

As a rule of thumb, at this point, every $1 change in average share price drives about a $2 million share swing in option dilution.

I hope the schedule sheds a little bit more light on the share count mass.

Turning to cash flow.

Year-to-date, we've generated $1,091,000,000 in cash from operations, less net capital spending, another 573 million from net borrowing, and 725 million from option exercises.

Of this, we used $27 million for [inaudible] acquisitions and returned almost $2.3 billion to shareholders, 549 million through dividends, and a total of 1.73 billion in shares repurchases.

Included in our operating cash flow for the second quarter is a tax payment of 760 million that relates to the IRS audit settlement of 2003, and we did talk about this in the Q1 call.

Year-to-date, cash taxes paid total $1,156,000,000 as compared to $324 million in the first half of 2003.

We are pleased with our working capital performance, which, if you adjust for the impact of the tax payment, was a net use of 374 million through Q2 and compares favorably to a net use of 558 million in the first half of 2003.

Keep in mind that because of the seasonality of our business, working capital tends to be a net use in the first half of the year.

The year-to-date net borrowing of $573 million is driven by the 500 million in medium-term notes we issued in May to take advantage of favorable market conditions.

This financing is essentially a prefunding of debt maturing in 2004 and was used to fund the tax settlement payment.

For the full year, we continue to expect our operating cash flow to total $4.9 billion.

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

This number assumes pension funding of 400 million and is consistent with past guidance.

And with respect to our full-year share repurchases, you should now expect repurchases to be in the range of 2.5 to 3 billion, which is an update to our previous guidance of 2.5 billion.

Let me now conclude with a few general comments about the business and our current full-year guidance.

As Steve said earlier, we are very pleased with the second quarter results.

Total business volumes are up 8%, which is virtually all organic growth.

The North American businesses are realizing positive price mix, driven by solid innovation.

We are gaining share across all our major businesses.

CBN and International had excellent quarters in the top and bottom line, and of course, salty business and Frito-Lay North America is performing very well.

We are seeing margin expansion across the portfolio as productivity programs deliver and more than offset a challenging inflationary environment.

And we are investing in our business process transformation project that will help position PepsiCo for sustained, long-term growth.

But we're also mindful of the challenges we face, which includes effectively addressing shifting consumer taste and trends with a well-balanced portfolio of products, maintaining consumer value at retail while coping with input cost pressures, facing more difficult comparisons in the second half as we lap last year's momentum, and anticipating a less favorable foreign currency environment.

As I read the momentum of our recent performance with the challenges we face, I'm reasonably optimistic about both the short and the long-term.

At this point, we remain confident in our standing full-year guidance, which is EPS of at least 2.29 and operating cash flow less Cap Ex of 3.4 billion.

Now let me turn it back to Steve.

Thank you, Indra.

And now let me entertain any questions that you might have.

Thank you. [Operator instructions.] One moment, please, for the first question.

Bill Pecoriello, you may ask your question, and please state your company name.

Morgan Stanley.

Good morning, everybody.

On the salty side you've seen some weakness in some sub segments like pretzels, corn chips and Doritos, due to consumer trends.

Looking out beyond the next quarter or two, what are the subsegments where you'd like to either bolster the portfolio or place more emphasis given those consumer trends?

And you also talked about the balancing of volume growth versus revenue per pound, so how confident are you in sustaining 2%-plus revenue per pound type increases mix in rate, while still gaining share watching the price gap?

Well, thank you, Bill.

That's a pretty full question.

Let me try to jump in here.

Let me say first that we really continue to believe that a balanced portfolio is what Frito-Lay's best potential is and will be in the future.

And that balances between the better-for-you and good-for-you products, along with the more indulgent products.

So the calendar for the balance of the year, I think you'll find is quite balanced across those portfolios.

Let me just give you a little idea of what that means.

We have been very pleased with the Lay's performance this year, and we're going to keep winning with Lay's for the balance of the year with things like regional challenges, with our product versus our regional competitors, which we have substantial wins against all of them and we're going to make sure we do that on a regional basis and we're very clear about it.

We have national programs with a new product introduction in Lay's, with the cheddar and sour cream product, and we're very pleased with the Stax introduction and we're going to continue to put pressure on that new product with things like a new product introduction with the salt and vinegar.

We've got some exciting cross-promotional ideas with regular Lay's, where we'll actually put a picture of Stax on a bag of regular Lay's and promote them back and forth, and we're going to step up our media campaign in Stax, talking about the taste superiority that we've documented versus Pringles.

And we think that's a very powerful message and will continue that, as well as very specific chain by chain pricing and promotion calendars for Stax.

And, of course, with Labor Day coming up, we have the Power of One promotion that features Lay's prominently.

So we think that Lay's has a big place in the future.

We're going to optimize our corn portfolio and that has two pieces to it -- two big pieces.

One is Tostitos.

We've talked before about repositioning Tostitos, and we're going to do that with new packaging.

We have now come up with 33% more capacity for Scoops; we've been capacity constrained since the day we introduced that product and we keep adding capacity, we have more capacity coming on.

We're going to be stepping up our messaging on Tostitos with the zero transfat message, and we also have some Labor Day activity, and I think some very interesting promotional activity with football, where we're going to actually feature some of the major teams and have a special bag size for the football season.

And also Doritos.

The Doritos obviously is performing below year-ago and we have plans in place to change that with a new flavor introduction called Pepper Jack, and new sizing that we're going to have in mass merch for the holidays, and Power of One and some pricing actions to make sure that we get the price right on Doritos.

And then the last item on the corn side is Cheetos, where we really think that the new product we're going to introduce in the second half of the year, which is a new baked Cheetos, has a lot of opportunity.

So, that's the second piece and then to the other side of your portfolio question, which is the better for you, we're going to bundle our products more effectively to get the consumer message out there, and we're going to reintroduce our Well line as -- reposition it as a light line under Lay's, Ruffles, Doritos and Tostitos.

We also have Edge coming out.

We have baked Cheetos as I just mentioned.

We have product change in Sun Chips.

We have some different graphics in multipacks for better-for-you products, and we have an exciting program that we'll be announcing on the 28th of July about how we're going to bundle all of our PepsiCo products for better-for-you.

So, that's sort of the balance and across all of that, Bill, is the idea that we're going to come out and tell the consumers a little more blatantly than we have in the past, that all of our salty snack fried products have zero transfats.

We did this over a year ago, as you know, but probably we probably weren't as clear in our messaging and it's a higher priority today, so we're going to come back out and put that zero transfat message on all of our products.

So, that's sort of the balance.

And I'd say, in my opinion, it's pretty well balanced across the indulgent line as well as the salty line.

And then second half of your question, which was price realization, you know, this is an art that we carefully watch from day-to-day as to how we can get price realization.

Because a large part of the price realization comes in promoted price, the effective promoted price.

And we think that through most of this year we've done a pretty good job of realizing that,

and if we can keep the same relative spread between volume and revenue for the balance of the year, we think that will be a pretty good way of getting the price realization that we need.

So that's sort of a picture of the second half, maybe a little longer than you asked for, but I feel very comfortable that we have the right balance for our program balance of the year.

Thank you very much.

Thank you.

Andrew Conway, you may ask you question and please state your company name.

Credit Suisse First Boston.

Thank you.

Steve, your carbonated soft drink volume was very solid and well above your longer term growth aspects.

I value -- and I know you mentioned Dawn may be on the call -- I value a little bit of perspective how the business did on a kind of broad-based channel perspective, and are you seeing more consumers coming back into the category?

And as a follow-up, within CSDs, would love to hear a little bit about how, with the powerful move up in trademark Pepsi growth, how sugar versus diets are moving.

And as you look to 2005, you have a great proprietary brand in Mountain Dew, other than Pitch Black.

Are there ways in which the selling and marketing proposition can be enhanced as we look, to the next year?

Dawn, you want to tackle those five questions?

Wow!

Let me try to cover them all.

Sorry.

First of all, we are pleased with the carbonated soft drink performance for Q2, and there's been a number of things driving it that we spoke about last year and that we've delivered on.

One is to make sure that we're balancing innovation against a focus on the core, large parts of the business, to make sure that we don't unduly take space away from Pepsi and from Mountain Dew.

So that has certainly benefited the business during the first half.

The second two things, obviously driving it, are that we are still benefiting from the Vanilla launch, and that our diet portfolio has really accelerated in its growth.

And I think over the long-term, when you ask what is happening with the carbonated category, it is consumers going more aggressively at younger ages into the diet category and accelerating that growth.

Regarding channels, we are seeing channels shifting, continuing, as people move from the grocery store trips to larger shopping experiences at the super centers and Wal-Mart and clubs, as well as our fountain business continues to grow ahead of our retail.

So we're continuing to see more of the same.

Regarding Mountain Dew, we continue to believe Mountain Dew is a tremendous trademark with a lot of opportunity.

And beyond the Pitch Black launch, in the longer extension of Live Wire on the marketplace through the Pitch Black launch, we are looking at continuing strong support of Mountain Dew into next year and continuing evolving our campaign, as well as putting more focus on diet Mountain Dew, which continues to be the fastest growing diet soft drink.

As consumers drink more and more diets, they want more variety in addition to their diet cola, so, diet Mountain Dew is obviously a great option for that.

I think I have answered all your five questions.

Thanks.

Dawn, you might just talk a little bit about the diet versus regular, and what you see going forward there?

What we see going forward is a continued shifting of people from two things.

In the regular category, we see people going from regular cola to looking at more flavored soft drinks, so they continue to move.

Obviously, our challenge is to make sure we continue to respect the fact that the cola is the single largest category.

And overall, we see people moving from regular soft drinks into diets, and hence the growth of both diet colas as well as diet flavored soft drinks continues to be the significant growth driver in the category.

The question becomes when you look at it, the launches of half calorie products, will that give people permission to come back and drink more?

It's too soon to say, but that's obviously some of the things we're looking for.

Thank you.

Thank you.

Bonnie Herzog, you may ask your question and please state your company name.

Good morning, everyone.

Smith Barney.

I guess I would like to ask a little bit of a follow-up question for Dawn on the Pepsi Cola brand.

I realize that trademark Pepsi volume grew in the mid single-digit range, but I would like to hear if the Pepsi cola brand volume grew when you back out the diet and the line extensions, the flavors.

Also, considering that many new line extensions have been introduced in the last few years in an effort to reinvigorate this core brand, I'd like your opinion on whether or not this is really working since a lot of money has been spent and the product life cycles of these new products appear to be quite short.

So I guess I was wondering if it would make more sense for your company to just simply devote all of your time, resources, and capital to the core Pepsi Cola brand, versus line extensions?

How do you look at this, Dawn?

Thank you.

Go ahead, Dawn.

A good and full question.

First of all, for trademark Pepsi, it is all about what I said before, which is the balance.

We did go back to putting more of our A&M support behind brand Pepsi because we believe that when you sell brand Pepsi, you halo the entire trademark of Pepsi.

We also put more support behind diet Pepsi, regular diet Pepsi.

So, I think going forward the right balance for us is to make sure that we do not take our eye off the ball of that part of the business which is largest.

Having said that, consumers are still drinking more and more ready-to-drink beverages, and they want variety and they want whatever is new fangled.

So for us to completely ignore their desire for new taste treats, even if they are on a short-term basis, I think would be not meeting what consumers want.

So our belief going forward is, again, to have the right balance between making sure that we have good support behind the base business of brand Pepsi and diet Pepsi, while continuing to offer flavor variety on an opportunistic basis.

Thank you.

Thank you.

Jeff Kanter, you may ask your question and please state your company name.

Prudential Securities.

Good morning, Steve and Indra.

Steve, as Frito International finally seems to be hitting its stride and you have more leverage to pull, to manage targeted results, how are you thinking about reinvestment behind Frito-Lay North America?

Are you spending more to drive these share gains and price realizations to build more viable, long-term -- a more viable long-term business model?

And similarly, do you feel like you're getting the appropriate return on your better-for-you products, given that Quaker has suffered a little bit here?

Thank you.

Well, good comments, Jeff.

I'd say, first of all, we don't subsidize one business for another.

We think that the international business has huge potential; we're starting to really see that step up.

We're going to continue to invest in that to the degree that we think is prudent to continue the growth and so that pretty much stands on its own.

And we're neither going to take the profits from International to invest in the U.S. or vice versa.

At some point in time maybe that would be a need, but we don't see that particular need today.

And we also believe that both businesses have growth potential and frankly, the Frito-Lay North America business, the investment in both the core business as well as the better-for-you, is an important part of today and an important part of tomorrow.

And I think it's important to separate the salty from the nonsalty better-for-you portfolio, particularly in this quarter, because the issue in better-for-you was not salty better-for- you, it was the Quaker portfolio.

And it was, you know, more specifically in the light snacks that go through the warehouse as well as through the bars.

And those issues are specific, and they really don't relate to the investments that we're making to build capacity in better-for-you in the salty portfolio.

So I feel very comfortable that both portfolios in Frito North America are important for today and important for tomorrow.

The real key for tomorrow is, as I made in my comments in my opening remarks, that the consumer wants better-for-you products, but different consumers have different needs.

So there isn't going to be a better-for-you product that's going to appeal to every person's need for some specific health need.

And that's going to be part of our challenge going forward, is to bring out the products that are targeted against the biggest needs first and make sure that that portfolio fits as many of the needs as we can find in the consumers.

And then, I also believe that the better for you product innovation gives us tremendous opportunity to get light users to come and become heavier users; it gives us a chance to get to some targeted audiences that we probably have not appealed to in the past, particularly senior citizens, with products that more meet their particular health needs.

So that part is important, and it also allows us a chance to get some price realization because these products are usually a higher-priced product and it gives us a better chance to balance our mix.

So I think, you know, overall both businesses have a bright future and we're going to continue to invest in both of them.

Okay.

Do you feel you have to reinvest more heavily going forward to sustain these share gains?

Thank you.

No.

Steve, maybe I will talk to this.

Jeff, let's separate out sort of the core CSD and salty snack business from the convenience foods and sort of the better-for-you stuff.

If you look at the DSD businesses, I don't think we're investing anything more than we did in the past; maybe a little bit more in media spending but fundamentally, the investment profile is the same.

As we go into the convenience foods and stuff that's sold through the warehouse, clearly, the push model alone doesn't work; you've got to invest in media and the pull aspect of the business, too.

So, what we are working our way through right now is figuring out how we can build a warehouse business, which came with Quaker acquisition, so that we can actually carve for ourselves a pretty good position in that critical-growth area in convenience foods.

So if you talk about increasing reinvestment, I'd say it's more shifting the investment from push to pull, and really establishing that whole convenience foods business that goes through the warehouse.

Okay, thank you.

Thank you.

Caroline Levy, you may ask your question and please state your company name.

UBS.

Good morning, everybody.

Pricing in beverages looks to me -- domestic beverages -- like it was up 2%.

If I got that right, it was a slowdown from some pretty big growth in the first quarter, and I just wanted to know what contributed and what to look for going forward there?

And then secondly, I think, Indra, that you said international trends should continue, and I want to clarify because operating profit in International has been up pretty close to 30% -- 20 to 30%.

Is that what you were referring to?

You think that's sustainable growth for a while?

No, let's be very clear.

The momentum -- let me address the International first, Steve, if that's okay.

The performance that International's delivered the first two quarters has been simply spectacular.

Now, I'd argue that anything above 15% is pretty spectacular, and what we're expecting is that the International growth will continue, you know, as Steve mentioned, in Q1, about two times the rate, or better, of the U.S. -- of the North American businesses.

To continue to deliver at the 20, 25% is unreasonable, Caroline, unless we continue to have tremendous tailwinds.

If I remember, Steve said in the first quarter it was a perfect sunny day, and International really had the perfect sunny day.

When I think spectacular, I think two times the North American rate is spectacular, and I think that's what we're expecting from International going forward.

Some quarters they may do better than that, but twice the North American rate would be very, very good.

The first question?

Dawn, do you want to handle that?

Well, regarding pricing, obviously, that is the expertise of the bottling system.

But we are very committed, as they are, to continuing to get price realization both through absolute price as well as mix and have a strong portfolio of activity to support that.

So I don't see that continuing.

Next question?

Our next question comes from Robert Vanbruek.

Ask your question and please state your company name.

Sanford Bernstein.

Good morning.

Good morning.

Steve, question about international beverages, and obviously the volume trends have been very strong.

And I was wondering to what extent is this due to, kind of , improving global macroeconomic trends and market growth, and to what extent is to due to market share gains?

Well, Robert, it's both.

And I think the piece that we're so optimistic about and so pleased with is the portfolio.

And we're seeing this, you know, from Europe to Latin America to Asia and all of our businesses, so there's no question that the economic macros around the world are favorable right now.

But I think that a large -- the overwhelming majority of what we're seeing in the beverage portfolio is on top of that, and as I said and as Indra said, it's getting scale, it's having a very well-focused portfolio with experienced leadership really driving the businesses on a local level with locally relevant products that have global leadership behind them.

So it's a sustainable model, in our opinion, and we're very optimistic about continued growth.

And if I would add to what Steve said, in the second quarter, in particular, virtually in every market around the world in beverages, we gained share.

Okay, great.

Thanks.

Thank you.

Eric Katzman, you may ask your question and please state your company name.

Hi, it's Deutsche Bank.

Good morning.

I guess the question has to do with the pricing.

Steve, I guess maybe six months ago or seven months ago when you had the meeting in New York, I'd asked you about inflationary cost pressure and you said it's extremely difficult and you're very reluctant to do something like across-the-board pricing.

But when you talked to experts out there, whether it's like ADM, or [Bungee], [Cargill], et cetera, and you look at some of the inventory levels for oils and stuff like that, it seems like there's a longer-term bias for upward costs.

So if you raise prices, when do you do that with the kind of understanding that you certainly don't want to go to Wal-Mart and other big retailers twice?

Well, I think this pricing pressure is -- there's no question it's out there, and I am as adamant on holding the line on our pricing as we possibly can but also recognize that when the trends continue we have to act accordingly.

And I think that what you're seeing in our actions;

that we're moving prudently to try to realize pricing where we can, we have very elastic categories and we have to be very careful about how we raise prices, but those cost pressures are clearly out there.

Okay.

And then Indra, if I could just follow up, in terms of the total company, I guess, if revenue is up 8 and volume, or servings, were up 8, and then you also pointed to in the text, I guess, currency, price mix, were also positives.

How much was the negative was promotional spending between gross and net sales for the total company?

No, let's be very careful here, because a lot of the -- the reason we didn't get as much of a spread between volume and revenue is due to International.

And what happens when you have an international business growing as much, where your revenue per serving is lower because of the currency mix, the countries from which that volume comes from, and when that growth disproportionately impacts the overall portfolio.

If you look at North America volume revenue spread, it was a solid two points.

It's when you accumulate the whole portfolio, it's the combination of beverages not being full goods, the mix of countries, and the fact that you have sources of revenue coming from different FX foreign exchange rates that causes the overall portfolio to not show as much of a spread.

And then as one last, sort of, a [inaudible] a factor, Venezuela, for example, posted double-digit volume growth, but because it's a joint venture, we don't consolidate the revenue into our P&L.

So we had a little bit of a P&L -- that revenue not counted in that revenue number.

Okay.

Maybe I'll follow up with Jack, thank you.

Thank you.

Mark Cohen, you may ask your question and please state your company name.

It's Goldman Sachs.

Good morning.

You know, one of the things that strikes me is that when you went and started to integrate the Quaker brands into Frito-Lay, you really looked to augment Frito-Lay's growth rate with those brands.

And you had also at the time you bought Quaker, some thoughts about how to extend and leverage the Quaker brand name into convenience foods, and I'm just noticing the innovation you have in the second half of the year is more salty snack oriented.

There is a little bit, I guess, of Quaker.

I'm just wondering if you could talk about your learning -- what you've learned about trying to leverage the snack business with the Quaker brand names and what you're learning about where you can use the Quaker brand name to expand the food operations?

Well, Mark, let me start by saying we still believe that moving outside the core salty is important for our future and we are still committed to doing that.

And we believe that the Quaker brand has the potential to be a large part of that; not the only part of it, but a large part of it.

And we've had growth in other parts of convenience foods, things like the Obertos brand, where we've gotten some strong growth and we think that the opportunities in ethnic products, specifically, in taking products like the Mesa products and bringing them into our ethnic markets, we've got a test going now in Chicago that's very promising.

So we think there are other ways to bring convenient foods, or foods not salty, and to leverage our go-to-market systems, both DSD as well as warehouse.

As far as Quaker is concerned, for the second half of the year, we're going to be focused primarily on getting the light snacks portfolio right, and getting that growth back in that business, and to focus on bars and to get the very highly competitive bar market back in our favor.

And that market has become much more competitive in the last two years than it was when we did the merger.

We still think it's a great category but it's certainly not without a strong set of competitors there.

And as far as using the Quaker name for other arenas, things like the breakfast squares we think has been a very positive move, and we think that bringing convenience into breakfast using Quaker name and bundling it with Tropicana is a great opportunity for us in the day part.

So all in all, we certainly learned some lessons in what didn't work, but we have no less appetite to continue to develop there.

I don't know, Indra, if you want to add anything to that?

I think, Steve, the Quaker brand still remains a fantastic brand that stands for nutrition, and the consumer is shifting some of their consumption to sort of better-for-you, good-for-you brands.

Last year we had success with the Quaker snacks.

This year, because of the competitive activity and failure of couple of products, we've had some overlap issues.

And I think the challenges to sort ourselves through this over the next couple of quarters, and I think the core market still exists as a consumer demand out there, and as long as we're in the snacking business as such a major force we have to participate in this.

So I think it's just sorting out the equation right and figuring out the winning formula.

Let me just rephrase this, maybe a little bit.

You know, you've had some successes applying the Quaker name to new things and you've had some things that may have had initial success, didn't follow through.

And you're putting the brand on some things that are surprising, like water.

I mean, what are the lessons of the wins and what are the lessons of the ones that didn't work out that you'd apply as you think -- is it new thinking that comes when you go forward and start to apply this?

Actually, Mark, that's a great question.

You know, one of the things we did recently is go back and take a hard look at the Quaker equity and really understand what's the soul of the Quaker equity, how extendable is it, what categories can we take it into, what categories should we not take it into.

And I think going forward, you'll start to see a lot more crisp execution in the Quaker brand in the PepsiCo portfolio.

Yeah, we experimented some in certain categories and products, but I think going forward, you're going to see extremely crisp definition of the Quaker brand and how we execute it.

Thanks, Indra.

Thank you.

Alec Patterson, you may ask your question and please state your company name.

Yes, RCM Capital.

Just going with one question, hopefully somebody else will ask about the business transformation costs in '05 and '06.

My question is regarding the nice table you put together on the options and dilution, and just trying to get a handle on where you think your net of repurchasing will take us by the end of the year on fully diluted share count?

I mean, it sounds like we should use a dilutive factor of around, I don't know, high 30s, 37, 38 million shares, going from basic to diluted for the next several quarters.

Is that fair?

And the other part of it is for you, Indra, you guys generate a lot of cash just from the option exercising.

It looks like you're going to be on course for about 1.4, $1.5 billion.

Do you figure your share repurchase dollar amount, the nearly $3 billion you talked about in the opening remarks, as net of those option proceeds or before them?

Lionel, do you want to take that?

First let me address the first one on the options proceeds.

And this is Lionel Nowell, the treasurer.

Options proceeds will be less than the 1.4 that you alluded to because in the first half of the year, clearly, I mean, we've been tracking on the high end, but that slowed down.

Secondly, when we speak to the 2.5 to $3 billion range, that's on a -- the gross number, not taking into account the option proceeds, so you'd have to back the option proceeds off that to get to the net, which would then put us, if you assume a billion of option proceeds, into the 1.5 to$2 billion range.

Yeah.

And by the end of the year, our expectation is that our shares outstanding should be somewhere in the 1.73 to 1.74 range.

Okay.

But you expect to get some traction then in the back half of the year?

I beg your pardon, I didn't hear that?

You expect to get traction on your repurchase --

Oh, absolutely.

Starting Q3 we start to get some traction, and then it builds up.

Okay.

All right.

Thank you.

Thank you.

Kristine Farkess, you may ask your question and please state your company name.

Thank you.

Merrill Lynch.

A quick question on Frito-Lay.

It looks like the price mix accelerated in the second quarter relative to the first quarter, a little bit.

Can you comment on what was different or was that driven largely by mix versus rates?

And specifically, if there any changes in trends in the convenience in gas channel with respect to Frito-Lay?

Thank you.

Price mix was probably more affected by holidays and the mix -- the promotional mix there than anything else, although it wasn't significant.

And there's a slight slowdown that we can sort of see in the gas, convenience in gas channel, but it's not -- at this point it hasn't been significant, but we did notice about a point drop.

I don't know, Dawn, if you would say you saw the same thing in the beverage side, but it was about a point in the snack side.

A little bit better in the beverage side.

Thank you.

Thank you.

The next question comes from Carlos Laboy.

You may ask your question and please state your company name.

Good afternoon, Bear Stearns.

My question relates to [Sobritos and Gemaysa].

I was hoping you could comment on the technological and structural evolution of your DSD systems in those businesses.

And also, do you have to invest very differently in '05 and '06 in Mexico to continue to drive the top line in your snack and cookie businesses there at these great rates?

No.

The Sobritas, particularly the Sobritas system, DSD system, we invest and continue to invest to keep the DSD system on a leading edge for many, many years.

There is nothing significantly different today, or planned for next year, over what we have done.

We are moving with rolling out handhelds further into the organization and deeper into the DSD system, but that's not revolutionary and it's not a significant change in cost structure.

And in terms of investing to support the continued growth, we're seeing a lot of productivity in the business and we believe that the productivity will allow us to get a large portion of that to capacity needs.

But obviously, over time, we will continue to invest, as we have in the past, in both of those businesses.

And we're very pleased with the volume performance, particularly in Sobritas so far this year.

Thank you.

Thank you.

This concludes our question and answer session.

I would now like to turn the call over to Mr. Steve Reinemund.

Well thank you very much for joining us today, and we appreciate your continued support and interest in PepsiCo.

Have a great day.