百事 (PEP) 2005 Q1 法說會逐字稿

Good morning and welcome to PepsiCo's first quarter 2005 earnings conference call.

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[ OPERATOR INSTRUCTIONS ]

Please note the Company's cautionary statement.

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

Our actual results could differ materially from those anticipated in any forward-looking statements but we under take 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 a discussion of specific risks that may affect our performance.

You should refer to the link at the bottom of today's earnings release which is contained in the investor section of PepsiCo's website at www.pepsico.com under the heading press releases.

To find disclosure and a reconciliation of non-GAAP financial measures that may be used by management when discussing PepsiCo's financial results with investors and analysts.

I would now like to turn the call over to Mr. Jamie Caufield, Vice President of Investor Relations.

Sir, you may begin.

Thank you operator and thanks to all of you for joining us this morning.

Welcome to our first quarter 2005 earnings conference call.

Today's webcast includes a slide presentation and can be accessed at our pepsico,com website.

As the operator mentioned, it's also being recorded and can be accessed for the next 90 days.

This morning our prepared remarks will be made by Steve Reinemund and our and CEO and Indra Nooyi .

Following the prepared remarks, we'll open it up for our questions.

And because a number of you are attending another industry event that's scheduled to begin following this call, we're planning to end the call by noon eastern time at the latest.

Now I'll turn it over to Steve.

Thanks, Jamie and good morning to all of you.

Thank you for joining us this morning and as always I appreciate the opportunity to discuss our quarter results and to provide some insights to the balance of the year.

As you saw in our release this morning we had a strong high quality quarter.

Our global servings were up 4%, revenue was up 7%, division operating profit up 10%, and earnings per share grew 15%.

And this quarter's results were lapping one of the strongest quarters for 2004.

You might remember me describing the first quarter of 2004 as the perfect sunny day with snack volume up 7%, beverages up 8% and revenue up 11%, while both division operating profit and EPS world were 15%, so in the context of lapping a really strong result like that from last year I'm very pleased with the quarters' results that we just reported.

Frito-Lay North America had very good topline results with positive price mix and volume was up 3% while revenue was up 6%.

We had strong growth in our four biggest brands, Lays, Doritos, Tostitos as well as Cheetos.

This growth was led by the continued success of Cheddar and Sour Cream Lays chips and Black Pepper Jack Doritos that were launched in Q4, from continued strong performance of baked, crunchy Cheetos and Tostitos Scoops and from the successful relaunch of our reduced calorie light line under the Lays and Tostitos brands.

We had strong revenue growth in a number of our other salty brands as well.

For example, Fritos grew in the high single digits and Sun Chips, Santitas Tortilla Chips and Miss Vickie's which is a premium kettle chip focused on the food service channel.

Each grew strong double digits.

I'm also pleased with the outside decor, the non-salty portion of our portfolio.

We had double digit revenue growth across products such as nuts and dips and high single digit growth in cookies and premium meat snacks.

And importantly, our Quaker rice snacks grew double digits in response to our ad campaign called 'Fad Free', and improvements to our packaging and our in-store merchandising.

Health and wellness oriented products continue to be a great opportunity for us and our Smart Spot eligible products once again grew faster than portfolio average with revenue up 13% in the first quarter.

Operating profit grew in line with revenue with flat margins and our plan assumed that we'd have fuel and energy cost inflation this year but the first quarter was unfortunately worse than we had expected.

The high oil prices impact our cost freight and energy for our plants as well as fuel for our route trucks and our over the road fleet.

And inflation of these items cost us more than 3 points of profit growth in the first quarter.

Although we had a good percentage of our diesel natural gas, even with these hedges, our costs were up versus 2004 and transportations costs that are not hedged like third party carrier fuel surcharges are also trending worse than we planned.

So looking into quarter two, we expect to see continued solid topline growth with good price realization at Frito-Lay.

Specifically we'll continue to benefit from much of the news that we saw in Q1.

We'll be stepping up our media behind Lays stacks to support two new flavors.

They are Hidden Valley Ranch and KC Masterpiece and launching our new improved Nacho Doritos and restaurant-style Tostitos with strong advertising.

Results on our consumer preference tests on new products have been terrific and the new products hit the market this month and will be supported by new ad campaign for the summer that we're calling 'Red, White and You'.

In our macro-snacks portfolio I'm encouraged by the momentum that we've seen in Q1 and in Q2 we'll be introducing our new packaging and advertising on our bar line to accelerate the growth of Quaker snacks.

So overall, I'm encouraged by the topline momentum that we see coming out of the first quarter and we have solid second quarter news and advertising that should maintain that momentum.

Now, while we're doing a very good job with over all cost management, fuel and energy will continue to be a head wind in the second quarter however our expectation is to see the cost pressures abate somewhat in the second half of the year and we'll have better overlaps which should help accelerate Fritos' operating profit growth rate for the balance of the year.

At Pepsi beverages North America, our 1.5 points of volume growth is lapping 2004 volume growth of 5% and this quarter's volume was driven by non-carbs up 8%, offset by 1 point carbonated soft drink.

Within non-carbs, we had double digit growth Gatorade, Aquafina as well as Propel.

And Gatorade benefited from the introduction of new lemonade flavor sub-line as well as was supported by strong advertising featuring Peyton Manning and the product went national in January and is making a very good contribution to the overall Gatorade growth.

We also launched some new tropical punch and grape flavors under the kids all star line and introduced the new Gatorade endurance product formula and these are all doing quite well in the marketplace.

Overall Aquafina grew strong double digits in the quarter and it was driven by both original Aquafina as well as the new flavor splash and sparkling lines that were launched in January.

And Propel is now in its fourth year in the market and it continues to post very strong double digit growth and is the leader in the enhanced water segment.

In the first quarter we launched the new melon flavor which together with the updated advertising which we call 'Drops' is doing a very good job in continuing to drive Propel's growth.

Tropicana declined in the quarter 2% and the volume performance was dampened by the price increase we took in the face of higher juice costs resulting from the hurricane crop damage last year.

While the volume performance is not in line with what we expect longer term for the business, it is in line with what we had planned in light of these price increases.

We continue to expand the Tropicana trademark and as you know last year we launched the Tropicana lemonade drinks and this summer we'll be launching Tropicana Twister carbonated soft drinks.

So, while the pure premium business will be challenged in the short-term, due to the pricing and cost environment, the overall Tropicana trademark continues to perform well.

On the carbonated soft drink line, diets continue to perform well and posted mid single digits in the quarter.

Trademark Sierra Mist was up low single digits.

Trademark Mountain Dew was essentially flat and trademark Pepsi was down low single digits, as we lacked the vanilla volume from last year.

And we saw with -- as we saw with Frito-Lay, Pepsi North America's Smart Spot eligible products are performing very well and they had a growth of 12% in the quarter.

Now moving to revenue, we had positive price mix which is largely resulted from the strength of Gatorade's growth, from the Tropicana chilled price increase, and from some concentrate pricing as well.

And this was offset somewhat by the timing of concentrate shipments which lagged BC -- BCF's growth.

Pepsi Beverages North America delivered 8% operating profit growth in the first quarter, which concluded a 4 point benefit related to our marketing accrual adjustment.

And this is lapping a very strong 20% quarter from last year.

Now looking ahead, we have strong innovation calendar for the second quarter with the launch of Pepsi Lime, the continued rollout of the new Pepsi ONE reformulated with Splenda, the new Lipton products and in June we'll be introducing Tropicana Twister CSDs.

And as you know, we're lapping our highest volume growth for 2004 in the second quarter, but as we move into the third quarter, the overlaps are much more manageable, so we should see the volume growth accelerate in the second half the year.

Overall I think we're off to a solid start at Pepsi Beverages North America and I believe we've got the new products, the advertising the customer programming that will enable us to achieve our objective of gaining liquid refreshment beverage share in 2005.

Now, moving to PepsiCo International, we had another great quarter there.

We had volume gains across just about every market in both beverages as well as snacks.

And as you saw in our release, the four major emerging markets continue to post strong double digit volume gains and we had a 20% profit growth lapping a 34% profit growth from Q1 of 2004.

In February we closed the transaction to acquire the roughly 40% interest in SVE joint venture in Europe from General Mills and the consolidation of 100% of SVE's profits within the first quarter added about one point to our Pepsi International's profit growth.

The transaction didn't have any impact on revenue or volume since we already reported 100 percent of SVE's top line.

Now, the dissolution of our snacks joint venture in South Korea did depress our reported volume growth in Asia but overall, our acquisition and divestiture activity did not have any significant impact on our results from the quarter.

The foreign exchange benefits you saw in this morning's release were largely the results of year on year strengthening of the British Pound, the Brazil Real and the Euro partially offset by a weaker Mexican Peso.

So the two issues that we're dealing with in international are the beverage business in Mexico City and Walkers in the U K. And I know most of you discussed the Mexico City beverage market with PBG during their curl -- call earlier this week and we're currently aligned with PBG on what needs to be done there and we believe we've got a solid new product and promotional plan set for the second quarter and we do expect to see sequential improvement in the volume there as the year progresses.

And as John Cahill (sp) mentioned on the call the volume in March showed improvement for the first two months of the year.

Now, at Walkers our volume was soft in Q1.

It was -- part of this was related to lapping strong growth from last year as well as having fewer trading days in the quarter, but overall, the category, the salty category in the UK has been soft.

In the second quarter we'll be changing the formulation of our Walkers snacks and chips to reduce the saturated fats by a third without compromising the great taste and we think this will have broad consumer appeal.

So as the laps ease moving into the year and we execute the reduced saturated fat introduction, we do expect to see sequential improvement in Walker's top line performance.

So net for the balance of of the year I expect us to continue with very strong momentum on the international business with solid growth in the emerging markets driving that business.

And as I mentioned improvement in the trends of Walkers and in the Mexican beverage business as well.

So our on outlook on currency has not changed since we spoke to you in February and we expect strength in the Euro to offset weakness in the Peso and a net positive impact for Pepsi International.

Quaker Foods North America had the best quarter we've seen since the acquisition.

We had strong oatmeal growth behind Take Heart and Low Sugar and Supreme Instant Quaker oat meal launches and Capt'n Crunch was up strong double digits behind swirl berries, and that was a very successful breakfast bundling activity that we had in the first quarter also helped our overall performance.

Quaker Foods North America is off to a great start and the first quarter provides some breathing room to fund the increased Quaker Foods A & M we talked about in February.

At this point let me talk -- turn the call over to Indra to walk through some corporate items.

Thank you, Steve.

As you can see we've got five points of corporate leverage in the quarter with division profits up 10% and EPS up 15%.

Let me walk you through each of the items below the division profit line to provide a little more color on the drivers.

Corporate unallocated costs were up 8% or 12 million.

The increase is driven by planned higher costs associated with our business process transformation and the timing of corporate department expenses, offset by lower stock base compensation charges in the quarter.

Bottling equity income was up 26 million of which $28 million was the pretax gain on our PBG share sales.

The underlying equity share and our bottler's earning for the quarter was down $2 million reflecting our anchor bottlers performance and the fact that we're picking up proportionately less of PBG's earnings due to the stock sale.

During the quarter we sold 1.8 million shares of PBG and our proportional ownership was 46% at the end of the quarter.

The after tax gain on the share sales was about $18 million or about $0.01 per share.

Net interest expense was up $2 million, interest expense on higher debt balances was largely offset by interest income on higher cash balances.

Our cash in investment balances are roughly in line with where they were at the end of 2004 and our debt is increased by approximately $800 million since year end.

Our rated average shares declined over 1% or 23 million shares versus the first quarter of 2004.

Basic shares declined by 29 million and although the number of total options outstanding declined by 17 million the dilutive impact increased as a result of the higher average share price in the quarter.

The scheduled attach to the release lays this out.

Finally our effective tax rate declined by 50 basis points from 29.5 to 29.

And this is largely the impact of a higher portion of earnings coming from lower rate International jurisdictions.

Moving on to cash flow.

Our management operating cash flow was $593 million which is a 10% increase from quarter one of last year.

We generated $233 million from option exercises and returned $887 million to shareholders in the form of dividends and share repurchases.

We repurchased 9 million shares of common stock at an average price of approximately $53 a share.

We also used $750 million to complete the acquisition of General Mills minority interest in SBE.

We are on track to deliver our full year cash flow guidance of $5.7 billion dollar of cash from operating activities.

We expect to spend approximately $1.6 billion on CapEx, and this is completely in line with the cash flow guidance we gave you in February.

Some of you have asked about the increase in cash and short-term investments on our balance sheet.

This is largely driven by geography.

As we generate International cash, it's not always immediately mobile.

So what you're seeing is an increase in international cash, and this is being offset by higher bottling in North America.

Our objective to remains to return our cash to shareholders through dividends and share repurchases.

Moving on, as this slide shows, from 2001 through the first quarter of 2005, we've generated $21.6 billion dollar in cash from operating activities and from option proceeds.

And the 21.6 billion has been invested in the following way: $5.7 billion in CapEx, 1.7 billion in acquisitions which includes the SBE transaction and $14.2 billion has been return ed ed to shareholders. 4.8 billion dollar in dividends and 9.4 billion dollar in share repurchases.

Let me now update our P&L guidance for the year.

You may recall the core EPS guidance we gave you in February.

At that time we said we expected division operating profit to grow 8% and that we expected 2 points or more of corporate leverage to deliver 10% plus EPS growth.

We are maintaining our operating profit guidance of 8%, despite the tougher commodities outlook for the year.

Most of our major input costs are tracking on plan with the exception of oil based commodities which are worse than planned year to date.

As I mentioned, we expect the cost pressure on oil to ease somewhat in the second half of the year.

Our corporate leverage outlook is a function of what we're referring to as sources and investments.

Within corporate and allocated, we expect leverage from core corporate G&A offset by incremental investment in our business process transformation initiative and an increase in unallocated pension expense.

This year should be the last year of incremental spending on our business process transformation.

Beginning in 2006 the spending should remain fairly constant and begin to decelerate in 2007.

Within bottling equity income, gains of sales of PBG shares will be a source of leverage and this will be offset somewhat by lower expected earnings from our anchor bottlers.

I've been asked by some of you why we are counting the PBG share gains in our core runnings so let me spend a minute on our rational.

Our objective with respect to the PBG share sales is to return to a level of ownership that approximates where we were at the time of PBG's IPO.

Our proportional ownership level has been increasing over time as PBG has been re purchasing its shares.

So we've initiated a program that we expect will take several years to gradually reduce our ownership to return to the IPO level because this is a multi year sustained program, we're not treating it as non-recurring, but we're reflecting it below the operating line.

So as you think about our long term algorithm, the share sale gains should be winding down at about the same time we expect our BPT investments to also be declining.

As you'd expect, we'll be very transparents with respect to the share sale activity.

For 2005 we anticipate selling up to 7.5 million shares under a 10B5-1 plan.

We expect our effective tax rate for the year to be 29 %.

This is 40 basis points better than the expectation we laid out in February.

And we've adjusted our full year guidance to reflect the impact of the 40 basis point reduction.

Finally our share repurchase target remains unchanged at 2.5 to $3 billion.

The net of all these items is that they should generate 2 points or more of EPS leverage.

And with the exception of a slightly lower tax rate, all of this is completely consistent with what we discussed in February.

Our EPS guidance on a reported basis is now at least $2.60 per share on a 53-week basis.

And excluding the impact of the 53 week at least $2.56 a share.

These estimates are a penny higher than what we discussed in February and that's because we are flowing through the tax rate upside into our guidance.

Even though I'm adding a penny to the guidance, the growth rate at the lower end of the guidance remains you unchanged at 10%.

I believe everyone has posted their first call estimates on a 52-week basis and to keep everything consistent, I'd encourage to you keep your estimates on a 52-week basis.

Finally, let me update you on our thoughts regarding the Patriation of International cash under the American Jobs Creation Act.

We are evaluating the provisions of the act and we are awaiting clarification on a few technical points.

We had hoped to be able to share with you our plans by now, but given some of the open issues, we decided it would be more prudent to wait until we get more clarity.

As we mentioned in our 10-K, it is our understanding that the maximum amount we are permitted to repatriate under the act is 7.5 billion.

We estimate the rate of tax in any amount we repatriate would be approximately 6% and any amount we repatriate must be repatriated in calendar 2005 to qualify for the favorable tax treatment.

And please note that our guidance does not reflect any impact for the repatriation of cash might have on our 2005 reported EPS or cash flow.

Let me turn this now back to Steve.

Thanks, in Indra.

And in summary, we had a very solid first quarter with balanced performance across all of our divisions.

And when I take into account the tough overlaps from last year plus some of the cost pressures that we're seeing, I'm very pleased with how we started this year.

And again as we mentioned in the release, I feel confident we are on track to deliver our full year commitments so with that let me open the floor to questions.

Thank you. [ OPERATOR INSTRUCTIONS ] Our first question is coming from Bonnie Herzog from Smith Barney.

Hi, everyone.

I guess I have a question regarding some of the A.C.

Nielson data.

I believe it indicates that the Frito-Lay volume has been soft year -to-date -- you reported something different.

So, do you think you need to improve possibly your approach in measured channels with the Frito-Lay portfolio?

And then I'm curious how much of the 3% volume growth that was -- was fueled by growth in the C & G channel and if it's a large amount I'm wondering how sustainable you think this is given the higher gas prices?

Bonnie, that's a great question, and I can take it in a couple of different ways, so let me take a stab at it.

You know, the measured results have been I think frustrating to all of us for several years and this is no different.

The unmeasured channels are where a lot of the growth is coming from, but to set your mind at ease, it hasn't changed dramatically from where it has been in the past couple of years in terms of the source of that growth, but let me just use your question as an opportunity to try to clarify the growth at Frito-Lay on a volume basis.

So what I'm going to talk about now is volume, not revenue.

If you'll look at the volume at Frito, the salty volume, the old traditional salty volume as we've defined it , we had close to 4% volume growth at Frito in just the old salty.

And if you take the non-salty, which is our, we've called it 'add more' or 'outside the core', whatever you want to call it, that's growing -- it grew about -- it was down about 6%, so overall, you put the two together, and that's how you get about the 3% volume growth for the year.

The points I'd like to make about that, however, are one, the Smart Spot area in the salty side of it was up 15%, and in the 'outside the core', it was up 8%, so the point I'd make here is that the volume that we're seeing coming out of this healthier products is quite encouraging and a lot of that is not coming in the measured channels, although some of it is.

Within the non-core products, we're making progress 'outside the core'.

As I mention in my prepared remarks, the rice cakes were very strong in the first quarter.

We think we had that business back on track.

We're now taking on the bar business.

We'll be introducing some new packaging and some new products in the second quarter and we expect that to come back on line, so by the end of the year, we should -- we expect to come out of the year with continued strong performance in salty and be on track to go outside the core.

But bring to closure your question, I really believe that the salty performance is even stronger than our release might have indicated because we have had strong results in the non-measured channel.

But, Bonnie, if I may just add to what Steve said, I'm looking at the IRI, Nielsen, and the total all channel.

The first quarter perhaps represents one of the best performances in measured channels.

Based on our data, total U.S. all channel measured which is IRI plus Nielsen C & G, volume grew for salty snacks slightly over 2% and revenue grew almost 3%, so this is a quarter where we had strong growth in measured channels and strong growth in unmeasured channels.

All right.

Thank you for that, and honestly, that was very helpful, but can you just touch on, you know, the higher gas prices and how you think that may or may not impact the C & G channel?

Yeah.

Well, you know, we've talked about this before when we've seen the price increases and some of the retailers have talked about it.

I know Wal-mart talks about it a lot as having an impact.

I can't say that the results we've seen in the first quarter are dramatically different than the year end results for 2004.

If it continues to move up, if the oil prices continue to move up, I can't imagine that it wouldn't have an impact, but we haven't seen it -- we haven't seen it yet.

Fair enough.

Thank you.

Thank you.

Our next question is coming from Bill Pecoriello with Morgan Stanley.

Good morning Steve and Indra.

Question on some of the risk factors looking over the balance of the year.

First on Coke's stepped up spending in beverages around the world.

Are you seeing it stepped up on certain markets?

How has it impacted your business thus far?

And if you aren't seeing it yet, what are you building into the plan for the balance of the year given the strong your international beverage performance was in the first quarter?

And then, just on Mexico, with the sluggish trends in CSD in the quarter, how much do you see as macro issues versus health and wellness impact and are any of those risk factors, do you see them impacting the snack business in Mexico as you go forward?

Bill, a number of questions you have in there.

Let me tackle a few and I'll let Indra help me with a few of them.

Let me start backwards with Mexico, I know you had some extensive discussions with John and his team on the PBG call earlier in Mexico.

Our issues -- we think we know pretty much where they are.

They're pretty isolated, primarily to Mexico City and we think that the execution of the plans that we have in place will address that issue.

It's not across the whole country and frankly, you know, our salty business as well as our sweet business in Mexico has been -- had a very good first quarter.

In fact, a very strong first quarter.

So we haven't seen the impact there at all, but -- and as John indicated, actually March has improved, so we, we're, you know, we're optimistic that that improvement will continue for the rest of the year.

Around the rest of the world, we're seeing stepped up investment in A & M. The results are, you know, too early to tell You are probably know, you're probably closer to those results than we are but we're certainly preparing as we've told in you previous calls to deal with the competitive issues, both proactively and reactively and we intend to do that.

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

I think, Steve, the way we're approaching it, Bill, is basically saying what kind of innovation can we put out in the marketplace and what can we spend on advertising behind the innovation to drive the category.

You know, in some ways, having the stepped up spending from Coke is good for the category because the overall category hopefully will get more buoyant, Bill, and as Steve said, in Mexico, outside of Mexico City, we've been gaining share and the volume's doing very well.

The issue is CSD share in Mexico City and the competition is with Coke and with B brands.

Gatorade on the other hand is doing exceedingly well in Mexico City and is up significantly.

In North America, as Steve mentioned in the call, we have a very good innovation calendar balance of the year across Pepsi, across Mountain Dew, across, you know, the launch of Tropicana Twister CSDs.

So we have a very good innovation calendar, we have a great focus on Smart Spot products and the whole diet portfolio, the expansion of the Aquafina trademark.

And then in Gatorade, with a continued focus on Gatorade Lemonade and the endurance formula, I think we have a very good innovation calendar and on our own the hope is that we will gain share and continue to deliver the great performance.

Great, and it sounds like you're being prudent on the balance of year forecast.

It doesn't seem like any of the stepped up spending has impacted the global beverage business yet but it's early in the year.

I think we are being prudent, you're right, Bill.

Thank you.

Thank you.

Our next question is coming from Jeff Kanter with Prudential securities.

Good morning, everybody.

Indra, quick question for you.

Actually two.

The high fructose corn syrup settlement, how is that a factor in your guidance if at all?

That's my first question.

My second question is, you know, you hardly have any, any, any debt on the balance sheet.

You know, you're very -- you're very conservative with the way you manage things, I realize that, but -- and I'm just -- what's driving that conservatism?

Is that that you want to make an acquisition because I see an opportunity to lever up a little bit and just, if anything, buy back even, you know, even more stock than you already are and returning to shareholders.

Can you just -- what's your rationale there?

Because it looks shareholder unfriendly to me?

Thank you.

The first thing under the settlement, Jeff, the details of the HFCF settlement have not been worked out.

When the details come in, we'll be back to tell you exactly how we're going to book it and what we're going to do with it.

Let me now turn to the debt on balance sheet.

You know, all the cash that we generate, over $4 billion that we plan to generate it year is going right back to you the shareholders.

It's going back through a combination of dividends and share repurchases and we borrow when we need to borrow.

For example, we needed to borrow when we bought out our share of the -- the General Mills share of the SVE joint venture and, you know, we borrowed money in Europe and made that acquisition.

So we borrow when we need to borrow.

Somehow I don't think it's prudent to borrow just to return it as dividends or increased share repurchases.

Our share repurchases are already at very attractive levels and our goal is to continue doing that.

As far as the speculation on acquisitions, as I've told you many many times, and I've shared this with all of you on the call, we have very stringent, strategic and financial criteria to make acquisitions.

We know what it is to go through a large post-merger integration coming off the Quaker Oats acquisition and we know what it takes to go through an FTC process so at this point while we don't have plans to make a large acquisition, were we to come back to you it will always be a deal that's passes strategic criteria, pass the financial criteria and we have complete confidence that we can execute the post-merger integration and create tremendous shareholder value and I hope at that point you'll applaud us.

Thank you very much.

Thank you.

Our next question is coming from Christine Farkas with Merrill Lynch.

Thank you very much.

A follow-up question to your earlier guidance, Indra, I just want to confirm given the stronger first quarter and the minimal boost in year -- in full year guidance.

It looks like the recurring gains from PBG sale and the better tax rate is, is almost offset by your view of costs in the remaining three-quarters of the year?

Well, at this point let's wait and see how oil prices trend.

The oil price trends are substantially higher than our plan and substantially higher than a year ago.

If the oil prices abate in the second half of this year, that creates a little bit more breathing room, but at this point let's just hold our judgment on that approximate

okay.

And if I can just follow up with a question on Quaker foods.

The margin was quite a bit higher than a year ago.

Do you think this expanded margin is sustainable for the rest of the year?

Thank you.

Well, we had an extraordinary quarter in the first quarter and we're very pleased where the business performance.

We expect to continue, you know, a strong business there relative to year-over-year I don't think it's going to continue to be the same proportion but, you know, as you grow this business, it does have leverage on the margin so we would expect to have a stronger margin closing out the year than we had closing out 2004.

Okay.

Great.

Thanks a lot.

Thank you.

Our next question is comes from Lori Hahn with Deutsche Bank.

High.

Good morning.

It's Marc Greenberg.

Just a couple of quick follow-ups.

First, I wonder if you might give us a little bit more detail on that marketing accrual and how we should think about it , whether that's kind of one time extraordinary in nature?

Additionally, Steve to follow up on your -- on your just answer, have you give n out any volume metrics on what the hot cereal business did in the first quarter?

Marc, I'm going to let Indra talk about accrual but just let me make one comment about it.

You know, we wanted to make sure that we were very parent in putting that out there but, you know, in the course of managing the business, there's pluses and minuses, and, you know, we try very hard to be as transparent but yet recognize that we have to manage both.

So to consider an upside or downside as an extraordinary is really probably not what you would want us to do and we don't want to do so I just put this accrual in the context of managing the business and the context of transparency.

Yeah, before I tossed it to Peter on the accrual, Steve, I just mention to Marc's call that base oatmeal grew in the low double digits.

Peter Bridgman, our Controller is going to give you a well thought through answer on the accrual, Marc.

Thank you.

Marc, yeah, just to give you some context, you know, if you look on the balance sheet you'll see over 5 billion of accounts payable and other current liabilities.

And over 1 billion as those relates to customer and bottler funding.

Many of those customer and bottler agreements are calendar agreements and they've got various performance criteria so year end we accrue based on our expected payout then finalize the payments in the following year.

In the first quarter 2005 the adjustment to the accrual was about 20 million compared to 7 million in the first quarter of 2004.

So that's the difference that represents the 4 points of profit growth.

This year we happen to resolve these accruals more quickly than 2004 and with so we recognized more of the adjustment in the first quarter.

If you look at the whole year of 2004, the final adjustment was also close to about 20 million which is obviously less than 2 percent of the total accrual, so I think as Steve said, this really shouldn't be seen as extraordinary and to some extent it may be timing within 2005.

Well, thank you for the clarification.

Just one follow-up question on the cost side.

Can you walk us through again some of the -- some of the primary cost components, particularly on Frito, where you think you're going to start to see some margin leverage in the back half.

Yeah, the biggest piece Mark is energy cost.

And, you know, earlier this year when we talked about procured materials outlook, we talked about the fact that we are hedged for a large portion of our energy cost at Frito, so the real cost increase has been in transportation where the fuel surcharges hit us pretty significantly.

And the other area where the Frito-Lay costs had been hit is some of the packaging material so combination of transportation costs and packaging have hit us disproportionately in Q1.

I think what you'll see is, through the second half of this year, if the oil prices stay at current level, you'll see some easing of the overlaps in the second half of this year, you'll see some carried forward in the pressure of Q2.

If oil prices increase from current levels in Q3 and Q4 you'll see continued pressure on the Frito-Lay cost structure, so both the transportation availability and the fuel surcharge are pretty concerning at this point.

But you are getting leverage on lower food oil and food input cost?

I would say for the other elements of the cost structure except those directly related to energy and oil, we are seeing some leverage year -over-year, yes.

Thank you.

Thank you.

Our next question is coming from John Faucher with JP Morgan.

Yeah, good morning, everyone.

Quick question on the working capital side.

Working capital was, you know, a bigger use of cash this year than it was last year's quarter.

Can you talk about some of the components there?

And in particular, you know, receivables looked a little better this quarter at least as a of sales, but maybe the finished goods inventory inventory was a little higher?

Can you just go over some of those items?

Thanks.

Yeah, John, the working capital numbers.

You know, there's a little over $100 million that I should explain. 50 million of that related to a payment that we had to make had in Q1 of some settlements of last year so that was the first one.

And the other 50 plus increase was because as our International business grows, the talents that we have internationally are different from the towns in the United States so as we talked about this this in prior year calls those always impact our working capital metrics deferentially.

All I can tell you is as I look at our North American business, which is a large portion of the company almost 70 percent plus of our profits, DSO, DPO, DII are all trending exactly the way we want them to, which is in the right direction.

Anything on that blip we saw in finished goods inventory?

Nothing to write home about it's just part of the Gatorade we just built inventory.

Our next question is comes from her Eric Katzman with Deutsche Banc.

Hi, good morning.

Steve, I had a question on I guess the promotional versus advertising spending that you listed in the annual report.

I guess it's 6.6 billion of promotion and 1.7 billion of advertising if I take that as percentage of either your gross or net sales, I guess however you do it , it's pretty -- I guess one, pretty skewed towards promotion and obviously pretty high in general and I'm kind of wondering as SAP kind of gets put into the system, how do you see that big promotional bucket being used more efficiently?

It's a great question.

I certainly would support the fact that SAP is going to help us manage the business better or wouldn't be doing it and Indra can talk more about that.

But really the nature of trade spending versus advertising spending has probably more to do with the fact that 80% or 70% of our sale 80% profits come at North America and for the most part we have push businesses in North North America rather than pull businesses which we have historically been places where we've spent money in that proportion.

So it it isn't a dramatic change over history, but it's certainly something that given the size of it , any bit of improvement we can have in managing it is going to have huge impact on the overall performance of the business.

Is that, you know, having listened to Irene's presentation at Cagney, I mean, as you kind of go into some of the other categories with the Frito-Lay brands, I guess in the Quaker brands, it sounds like you could be more pull than push.

Is that a fair characterization and would that change the mix at all?

Oh, I think that's right, and I think Irene did a good job of talking about that .

And there's really two factors here.

One, we're moving in to -- as we move outside the core, we're moving into products where our competitors are -- go to market differently.

And secondly, you know, our intention with particularly Frito-Lay North America, is to add more consumer marketing to the equation to drive -- to drive our business.

So it would be our expectation over time to see that change, but it isn't going to be dramatic.

Okay.

All right.

Thank you.

Thank you.

Our next question is coming from Mark Cohen with Goldman Sachs.

Good morning.

You know, I wanted to build actually on the question that Eric just asked.

And, and, Steve, I wonder if you could just give us some perspective on, from your experience on what -- doesn't look like a strategy change at Frito-Lay, but looks like a different tact for attacking the -- you know, the ability the gross share in the macro snack market.

I mean, four or five years or six years ago I think you were emphasizing doing this with add more, and it seemed that Irene suggested a subtle change in trying to stretch the core brands into -- either through different use educations or different -- bring them into different categories, into just taking share less directly, you know, from other alternatives.

Can you talk about how that strategy has evolved from your perspective?

I think Irene did a very good job of articulating what we're trying to do both inside the core and outside the core.

I'll just use my own words, but, you know, as we take that huge salty business, which we have a very good position in and a lot of knowledge in, trying to segment our products and segment our consumers against product needs and usage, we think gives us an opportunity to grow the overall category and to benefit from that because frankly given our share position growing that category versus the rest of macro snack is obviously advantageous to us.

So Frito's efforts to further understand the consumer, to target our products against the consumer, and to spend more consumer advertising to get that message out there we think will pay big dividends and, frankly, one of the things I tried to do in an answer to a previous question was to point out the strength of that core salty business.

I mean, the volume at Frito-Lay in the core salty business in the first quarter that's probably one of the highlights, as far as I can see, if in the whole business because that's a huge business and to grow close to 4% in volume is quite strong.

Now, at the same time we're trying to move more deliberately, more targeted outside the core , recognizing that this is a tough challenge, and any company that tries to move outside the core as subtle as it might be is not an easy proposition, and we're going to have to carefully do it and we're going to have to spend consumer money to get there, and we're going to have to have sustaining capability to keep it up, but we want to do both.

So, Mark, to answer your question is it isn't a change to our strategy.

It's really stepping back and saying let's take our strength in salty and make sure that we we aren't in any way backing way from continuing to grow that category and do it smarter and harder and at the same time be very prudent about how we move outside the core.

Let me try -- can I try a different way of it.

Five years ago when you were running the business or back when we all met in Dallas, the idea was to add more - add more growth to Frito-Lay by moving into the add more categories.

It seems to me that now you think you can add more growth to Frito-Lay more in the core categories by marketing them differently, and that's the subtle change I was talking about.

I was just wondering from, you know, having been there through that whole process and to what Irene's brought, if you can give us better perspective on why you think the core should grow faster.

Well, I start by saying it's probably a lot better managed there now than when I was there, so, but I don't think it's changed.

I think, you know, any company that doesn't constantly re-look at how to do their core business better is walking away from the biggest opportunity and the most important objective that you have, so I think a fresh set of eyes looking at the core business in a different way, obviously you're going to get some subtle differences to it, but I never me want to suggest five years ago that we were moving away from the core business in any way at all.

And frankly, you know, and the people at Frito have heard me say this, until we get to 100 % share market there's still share opportunities and as long as there are consumers out there that are trading off our category versus others, there's opportunities to expand the category, so that hasn't changed.

I just think, you know, maybe we have a new perspective at it.

One of the things that -- and I said this but let me say it again.

One of the things we worked at for years but we're working even harder at is trying to segment our consumer needs and our -- and align that with our products in a more compelling way so when we, you know, when we spend a dollar against a product, we're not -- we're doing it specifically at a consumer need and we're not cannibalizing as best we can any other products in our own portfolio because we've targeted that message very carefully.

Can I just ask one more question and ask Indra if you would elaborate on any progress you may have been thinking about how you would deploy the $7.5 billion of gross, in the gross $7.5 billion of offshore money?

Basically it's for reinvestment in the business.

We look at all the guidelines that have been recommended by the IRS and we'll make sure we follow those guidelines, Mark.

We're still working through the details as we speak.

Okay, thanks.

Our final question is coming from Pasha Masagi (sp) with Nicholas-Applegate Capital Management.

Hi, guys.

Congratulation for the great quarter.

I just had a question on Splenda?

How do you think the supply is out there?

I know the supplier is increasing capacity but do you think you're going to be able to get all you need for Pepsi One?

And the other side of that question is whether you are considering using Splenda in your other products and whether you are thinking of investing in a similar product for yourself to come up with something similar to Splenda?

That's all.

Thank you.

First of all, the product supply of Splenda we're quite confident that we have all the supply we need for the product plans that we have for this year, and we have no interest in investing in that business.

We're quite happy with the suppliers that we have and feel that -- quite frankly in the Splenda case, the product is -- has got a lot of consumer appeal because of the marketing that's been put around that base product, and there are a lot of our brands that are looking at the possible use of sweetners, artificial sweetners and Splenda is certainly one of those.

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

I just -- I'll echo what you said.

I think we have enough supplies and we are working with the suppliers to make sure that we have all the capacity we need for our products at this point.

And has the pricing been any difficult from the suppliers side?

We always like lower prices, but no.

Okay.

All right.

Thank you.

Thank you.

At this time I would like to turn the floor back over to Mr. Reinemund for any closing remarks.

Well, thank you all for joining us this morning.

I know you have a busy day and you have other obligations.

As you can tell from our release and from our conversation over the last 45 or 50 minutes that we're pleased with the way this year has started out.

We're optimistic about the balance of the year across all of our businesses, and we look forward to talking with you and working with you throughout 2005, and thank you for joining us.

Thank you.

This does conclude today's tele conference.

You may disconnect your lines at this time, and have a wonderful day.