百事 (PEP) 2005 Q2 法說會逐字稿

Good morning and welcome to PepsiCo's second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS]

Please note the Company's cautionary statement.

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

Our actual results could differ materially from those anticipated in such forward-looking statements, but we undertake no obligation to update any such statement.

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 investors 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 Caulfield, 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 PepsiCo's second quarter 2005 earnings conference call.

Today's webcast includes a slide presentation that can be accessed at our pepsico.com website and, as the operator mentioned, it's also being recorded and will be available for the next 90 days.

On this morning's call are Steve Reinemund, PepsiCo's Chairman and CEO, Indra Nooyi, PepsiCo's President and CFO, and Dawn Hudson, President and CEO of Pepsi-Cola North America.

Following Steve and Indra's prepared remarks, Steve, Indra, and Dawn will be glad to take your questions.

Our expectation is to wrap this call up by noon, at the latest.

And it's now my pleasure to introduce Steve Reinemund.

Thank you, Jamie.

Good morning, everyone, and thank you for the opportunity this morning to discuss our second quarter results and our outlook for the remainder of the year.

As you saw in the release this morning, we had another very strong quarter, both on the top line and the bottom line.

And I'm very pleased with the results of the operating units.

And I'm pleased, particularly, in light of the significant challenges that are in the marketplace today.

In addition to overlapping a very strong quarter from last year, we had to deal with some cost pressures and, as always, a tough competitive environment.

And I'll comment on these in more detail as we go through each division's results.

But I think our performance in the quarter and the first half demonstrates the power of our portfolio businesses and their ability to respond to the challenges to deliver very strong results overall.

So let's just spend a few minutes reviewing the numbers before we get started talking about business.

Worldwide servings were up 4%, which is a result of global snack volume that was up 3% and beverage volume, which was up 5%, while revenue was up a very strong 9%.

And this resulted in division operating profit growth of 10% and EPS growth of 15%.

And this quarter is lapping very strong quarter from last year, when servings were up 8%, revenue up 8% as well, division operating profit up 11, and EPS up 12.

As you saw in the release this morning, on the strength of the first half results, we've raised our earnings outlook for the remainder of the year.

Let me spend some time reviewing each of the divisions in a bit more detail.

First, Frito North America.

Frito had another very solid quarter with strong broad-based top-line growth.

We had strength in both salty snacks, as well as in other macro snacks, and the new products and base volume each contributed to growth, and were able to offset significant inflation with very effective price and mix management, as well as productivity.

And let's just quickly review the numbers at Frito.

Overall volume was up 2.5%, while salty volume was up almost 3%.

We had very strong positive price mix to deliver 6% revenue growth, and profit grew in line with revenue.

On the top line, Lay's, Tostitos and Cheetos had very strong revenue growth, with each trademark growing in high single digits.

Lay's is benefiting from new products, like a new cheddar and sour cream flavor of Classic Lay's and three new flavors of stacks;

Pizza, Hidden Valley Ranch, and KC Masterpiece.

And the Lay's Lite product did quite well.

We're pleased with these products performance, and they've shown strong consumer trial, repeat, and acceptance.

And the new products, plus the base brand, are also getting a lift from our new advertising campaign called 'Get Your Smile On.'

Now, Tostitos is benefiting from the continued strength across the line from Scoops to the reformulation and relaunch of Restaurant Style Tostitos, as well as getting support from media overall.

The total Cheetos trademark was up in high single digits, and continues to benefit from the baked crunchy products that we launched late last year.

The product tastes terrific and qualifies for our Smart Spot designation.

In fact, we continue to benefit from consumers' interest in healthier versions of many of our products.

For example, I mentioned the success of Lay's Lite.

The growth on the total lite sub-line that we launched -- relaunched late last year includes Lay's, Tostitos, Doritos, and Ruffles, and they were up over 30% in the quarter.

And Sunchips, our multigrain snack, also had double-digit revenue growth.

In total, our Smart Spot eligible product portfolio grew revenue in the mid-teens this quarter.

We're also very pleased with the performance in the other macro snack products of Frito-Lay with revenue growth in the low teens.

We had double-digit growth on Quaker bars, behind the reduced sugar product launches, including new packaging and advertising that very effectively leverages the Quaker equity.

And our Quaker rice cake products also grew double digits, with new packaging as well as new advertising.

As we mentioned in the release, margin expansion was constrained by cost inflation again this quarter.

Labor and benefit costs were higher, although mitigated somewhat by a favorable casualty insurance adjustment related to improved safety performance and fuel, which was a bit worse than planned.

Now Indra will take you through this in a bit more detail when she comments on import costs overall.

But the bottom line on Frito is, even with fuel and energy inflation, our expectation is to return to generating operating profit margin improvement in the second half, as the comparisons of our other input costs ease.

Now, on the top line, we'll continue to benefit from a solid innovation calendar and strong marketing.

We'll be launching a new multi-pack of 100-calorie snacks under the most popular brands, and a line of Lay's-branded dips in both french onion as well as ranch flavors.

And on a regional basis, we're introducing a lightly-salted version of Lay's potato chips, a flaming-hot version of baked crunchy Cheetos, and a line of Doritos hot products.

And following on the success of the reduced sugar Quaker Fruit and Oatmeal bar we're launching a reduced sugar Quaker Chewy Granola bar.

In addition, in the second half we'll see a more pronounced benefit from our stepped up ANM investment, as we lap lower media weights from last year and from a new Tostitos campaign that we'll be launching shortly.

Now turning to Pepsi Beverages North America.

Now, while we're never satisfied with a volume decline, I think we have to look at the quarter's performance in the context of the numbers we're lapping from last year.

I feel good about our product calendar, both in CSD's and non-carbs, and I'm pleased with our advertising copy and media plan.

As we hit the easier comparisons in the second half and get to the full benefit of our new product introductions, we expect to see a return to positive volume performance.

For the second quarter, we had a volume decline of about 50 basis points, revenue was up 4%, and operating profit was also up 4%.

We're lapping our strongest quarter of 2004, when the volume was up more than 7%.

So, if you look at it on a two-year basis, the growth averaged over 3%.

In addition, as we mention on the Q1 call, Easter holiday timing this year penalized Q2 volume by about a half a point.

Net revenue benefited from pricing and favorable year-on-year trade spending, including the settlement of prior year accruals.

Now, let me take a minute to walk through the portfolio.

In just about every case, the comparisons from last year were tough, and that's had an impact on Q2's volume.

First for CSD's.

They declined 4%, lapping 4% growth from last year.

Regular CSD's were down mid single-digits, and diets posted low single-digit growth.

We believe the CSD category has the potential to grow in positive territory.

And, as I mentioned, in the second half we expect to show improvement, as the comparisons ease and our innovation kicks in.

Much of our innovation has just launched and we didn't get the full benefit of the new products in the second quarter, which ends in May for the purposes of reporting volume.

Over the past several months, we've launched reformulated Pepsi ONE, as well as Pepsi Lime in both regular, as well as diet.

In June we launched a new line of Twister flavors in orange, grape, and strawberry.

Now, although it's early, all these products are in line with or ahead of our expectations, with strong consumer trial as well as repeat rates.

Non-carbs grew 5% in the quarter, lapping 14% from 2004.

The base products continue to perform well.

We've got a great lineup of innovation that's just hit the market, and we have the greatest non-carb advertising calendar in our history.

And moving on to Gatorade.

Gatorade grew 3%, lapping a mid-teens growth from last year.

And although this growth is below our trends over the past several years, I'm very happy with the state of this business.

The new lemonade sub-line is doing quite well this year.

We have great copy and our shipments so far in the third quarter have been very strong and are well over 20%.

Our total water franchise grew over 25% in Q2, lapping more than 35% growth in 2004.

Base Aquafina had very strong growth and we're happy with the early read on Sparkling and Flavor Splash lines.

And we're pleased with our base Aquafina campaign, which is 'Drink More Water.'

And we're quite pleased with the advertising, as well.

Propel continues to grow strong double-digits, aided by the new melon-flavor introduction, and a great new ad campaign that's an update to the very distinctive Propel ads that we call 'Drop.'

This is a great product, and it's extremely loyal consumer following.

Now, Tropicana Chill declined low single-digits.

Given the pricing we've taken this year, we expected weaker volume performance in the near term.

As you know, we've taken pricing on this product to cover the increased juice cost.

The pricing appears to be holding, and we've seen a favorable impact on Tropicana's profit performance.

And the early read in Q3 shows that our volume trends are improving.

Now, we launched the new Lipton Iced Tea in P.E.T. bottles this year and it's doing extraordinarily well.

The Green Tea produce is particularly strong.

It has very high velocities, distribution is building and, again, it's being very effectively supported with great advertising.

So net-net, we continue to believe that the LRB category should grow about 2.5% this year, and we feel very good about the brands and the product portfolio we have to compete in this category.

Now, as we said in January, our objective is to grow ahead of the category.

Coming into this year, we knew the growth in the first half would be tough, given our comparisons.

As a consequence, we've given up about 3/10ths of a share point in total LRB through the first six periods.

Over the balance of the year, my expectation is for both our share performance and our volume growth to improve.

As we head into the second half, our earnings guidance includes investments to ensure we regain growth momentum.

There are funds that we've had in the plan ever since the beginning of the year.

We're prepared to invest aggressively on initiatives that will achieve sustainable volume gains.

As a consequence, in the third quarter you should anticipate seeing some impact of the investment spending in PBNA's profit performance.

Now moving on to International.

The division again had an outstanding quarter.

Volume was up 3% in snacks and 10% in beverages.

Revenue was up 15% and profit was up 23%.

And the division was lapping last year's very strong Q2, when it had double-digit volume growth in both snacks and beverages and profit growth was over 20%.

We had broad-based gains in beverages across just about every market, with high single-digit CSD growth and high teens growth in non-carbs.

On the snack side, we had very strong growth across Asia, the Middle East, and Latin America, but the volume was soft in Mexico and the U.K.

Now, in Mexico, Sabritas showed a slight decline driven by selective weight-outs and the fact that we are lapping double-digit volume growth in 2004.

On a local currency basis, Sabritas posted solid revenue and profit growth, and in the second half we're strengthening the promotion and innovation calendar to restore volume growth to the business.

At Gamesa, we're seeing some softness in the cookie category, but we're adjusting pricing and promotions in the second half and we're confident that we'll see sequential improvement in their performance. as well.

And at Walker's, on the Q1 call we highlighted the retail trade issues in the U.K., and. as anticipated, we saw sequential improvement from Q1 to Q2.

And we expect to see continued improvement, as we move into Q3.

Most of the volume's softness has been associated with our promotional frequency, and we're adjusting our trade calendars accordingly.

So net, a great quarter for International.

Beverages and snacks had very strong growth, with the exception of snacks in Mexico and the U.K..

And these markets, we're confident we'll see improving trends in the second half.

We've had great profit performance in the first half, and that's giving us flexibility to invest in the business as we move into the second half to sustain our top-line momentum.

So you should expect to see the impact of these investments in the division's second-half profit performance.

Now to Quaker Foods.

Quaker Foods had an exceptional quarter.

Volume grew 12%, revenue was up 16%, and profit grew 24%.

As you can see, this business had very good profit leverage with strong volumes and price realization.

On the top line, we saw gains across the board.

Oatmeal, Rice-A-Roni, and Aunt Jemima each had double-digit growth, driven by strong innovation and distribution gains in non-traditional channels.

Oatmeal benefited from the launch of the low sugar and heart-healthy products, and improved velocities on the base business.

The Roni side dishes had very solid growth, driven by innovation on Roni Express and World Flavors.

And Aunt Jemima's growth was driven by distribution gains in alternative channels.

Now looking into the second half, we're more cautious about Quaker's top-line outlook, because the comparisons get tougher as we lap second-half 2004 new product launches.

And given the strong first-half profit performance, we're likely to make some ANM investments in the second half to establish some momentum going into 2006.

So that's it for the operating businesses.

Now let me turn the call over to Indra.

Thanks, Steve.

I'll review the items below the operating line and cash-flow performance, and then I'll update you on our outlook for commodity costs, foreign currency, and our full-year earnings guidance.

We 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 operating profit line to provide a little bit more color on the drivers.

Corporate unallocated costs were up 19%, or $26 million in the quarter.

The increase is driven by planned, but higher, employee-related costs in the quarter and increased investment in our business process transformation initiative.

Year-to-date, corporate costs are up 38 million, and more than half increase is related to our PBG investments.

Broadening equity income increased 47%, or $50 million in the quarter.

The increase includes the pre-tax gain on sales of PBG shares of $35 million.

You may recall that this year we initiated a multi-year program to return our proportional ownership in PBG to approximately the level at the time of PBG's IPO, which was about 40% on an economic basis.

As we've said in the past, we expect to sell up to 7.5 million shares this year.

Through the end of Q2, we've sold 3.8 million shares for a pre-tax gain of $64 million.

And our proportional ownership on an economic basis, at the end of the second quarter, stood at approximately 46%.

The remainder of the bottling equity income was driven by our share in the equity bottlers earnings, an increase of $15 million, or 14%.

And this reflects earnings strength across most of our equity bottlers.

Net interest expense was flat for the quarter compared to last year at $25 million.

We had favorability rates, both on cash and debt and higher cash balances, offset by the impact of higher debt balances.

Finally, our effective tax rate declined by approximately 25 basis points compared to the year ago quarter, and is now 29.3%.

The second quarter rate is a bit higher than our projected full-year rate, which we are projecting to be 29%.

Moving on to cash-flow, our management operating cash-flow for the first half was $1.9 billion, a 77% increase over the first half of last year.

The improvement includes the favorable lap of the $760 million IRS audit settlement payment we made last year.

We generated $590 (ph) million from option exercises and returned $2 billion to shareholders in dividends and share repurchases.

We repurchased 23 million shares of common stock at a year-to-date average price of approximately $54 per share.

Our share repurchase target remains at $2.5 to $3 billion for the full year.

We are pleased with our operating working capital performance in the quarter, with all our key metrics comfortably within our targets.

Both DSO's and DPO's showed improvement versus the same quarter last year and sequentially from the first quarter.

Our days in inventory are up sequentially, which is driven by the seasonality of our businesses.

But the days in inventory are down slightly compared to Q2 of last year.

We remain on track to deliver our full-year cash-flow guidance of about $5.7 billion in cash from operating activities, and our net capital spending target remains around $1.6 billion for the year.

Let me comment briefly on the outlook for commodities and foreign currency.

Coming into the year, we said we expected net input costs to be roughly neutral for Frito, with inflation in the first half and deflation in the second half.

And we expected input inflation at Pepsi Beverages North America, largely driven by pet resin and orange costs.

At this point in the year, the only major variance from our original expectation has been on energy and fuel.

And I think we've done a pretty good job, as a portfolio of businesses, to manage through the cost pressure and deliver very strong profit performance.

Moving into the second half, we are seeing easing of inflation on a number of our inputs, with a net inflation for our key strategic materials in North America a bit lower in the second half than in the first half.

There remains some risk on oil and energy, but I want to emphasize that at Frito, where we have the largest exposure on a direct basis, we have 80% of our requirements hedged.

We are exposed to third-party fuel surcharges but we expect that, in the second half, Frito will see inflation on the other key materials abate, which will somewhat offset fuel-related cost increases.

I don't want to dismiss the fuel and energy exposure, but it's important to put it in perspective.

At Frito, fuel and energy, both direct and indirect, make up about 4% of the total cost structure.

Our team at Frito has done a very good job offsetting inflation with productivity and tactical pricing, and you should expect them to continue to do a very good job in this area.

Moving on to for-ex, as many of you know, our key non-dollar currencies are the Mexican Peso, the Pound, the Euro, and the Canadian dollar.

In the first half, we had a net foreign currency benefit of one point to revenue and operating profit growth, with the Peso roughly flat, the Pound up 3%, and the Euro up 5% versus last year.

In the second half. we expect the Peso to be flat to slightly stronger and the Euro and the Pound to weaken somewhat.

On a net basis, given this outlook, I don't expect the significant for-ex impact in the second half.

Now, let me update you on P&L guidance.

First of all, we are very comfortable with our line of business guidance for the full year at 8%.

And as you saw in this morning's release, we now have our EPS guidance at 256 to 259 on a 52-week basis, and 260 to 263 on a reported basis, which includes the 53rd week impact, reflecting our confidence based on the strength of our first-half earnings performance.

As Steve mentioned, we do intend to step-up investments in North American beverages and in our international business.

And Quaker Food North America's profit performance in the second half will be lower than the first half performance, as we expect to see the top line slow down a bit, and as we make investments in advance of 2006.

As you build your models, you should also anticipate that the increase investments will have a greater impact on the third quarter than the fourth quarter.

So our third quarter growth rate will likely be lower than the fourth quarter.

Net-net, we are very happy with the performance of our businesses through the first half, which is allowing us to make some strategic investments in the second half, and at the same time, deliver what we expect to be a very solid full-year performance.

Now let me turn it back to Steve, and we'll be glad to take your questions.

Thank you, Indra.

And now, operator, we're -- we'd be ready to take questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is from Bill Pecoriello of Morgan Stanley.

Morning, everyone.

My question is on the U. S. beverage industry.

We look year-to-date, the CSD category is down about 3 to 4%, which is weaker than expected.

And water has been a big driver on the offset of that, which has been price driven.

As you talk about these investments you're making in the third quarter, you've anticipated the Coke spending before the year began.

Anything you're seeing in their actions or the effectiveness of that spending that makes you feel better or worse about the levels that you've planned, and what exactly are you going to be spending behind in terms of trial for your new products or any increased promotion to help out your volume and share trends?

Thank you, Bill.

I think what we're starting to see from our competitors is -- is what we expected, both in new products as well as in spending.

And maybe to give you a little more flavor to that, let me ask Dawn if she'd comment.

Hi, Bill.

Hi, Dawn.

First of all, just a comment on the overall CSD category.

While the first half trends for CSD's in measured channels are down four, that does compare with full-year '04 down five.

And just a reminder that we continue to see movement toward the unmeasured channels, both food service and unmeasured large retailers.

So, the fact that the measured channel is down point -- down 4% doesn't mean that that's where the category will net out for the full year.

Regarding competitive activity, I guess the first thing I would say is we are going to play our game, which was to step up investment and place that investment behind news that we think will provide long-term sustainable growth.

And we are putting that investment behind both marketing, advertising, and promotion, behind our portfolio of CSD, and significant increase in our non-carbonated innovation.

So, the innovation we have in Sparkling and Flavor Splash for Aquafina, our new launch of Lipton Ice Tea, line extensions of Tropicana fruit juices, as well as Pepsi Lime, and the relaunch of Wild Cherry Pepsi and Pepsi ONE.

So, again, I would say we're going to continue to play our game and focus on building long-term trademarks and investing more in advertising and promotional activity, as well as key partnerships with our customers to drive incremental programs.

We have, a question you may ask, we are putting more money also into couponing.

We think it's very effective tool, in partnership with everything else, to drive trial, to drive increased pack rate.

The question we are looking at right now is, there seems to be competitive activity where couponing is resulted in direct price-off at the cash register, and are looking at what we believe the long-term impact on the category is.

Again, we think it's very important that the incremental brand investments be placed in a way that provides sustainable growth.

And I just might add a couple of quick comments on Tropicana and Gatorade.

We had anticipated, as I said in my script, the softening in the first quarter of Tropicana, based on the pricing action at the end of last year, and we anticipated that the volume would come back, and it has.

The numbers that we're seeing in our third quarter, so far, are very encouraging in terms of volume, as well as revenue from Tropicana.

And as far as Gatorade, we're off to a terrific start for the third quarter.

We're on trend now to have the strongest performance from Gatorade that we've probably ever seen.

And a lot of that's impacted by favorable weather that was not as favorable in the second quarter.

But both Tropicana and Gatorade will -- we expect to have significant contributions to volume and revenue in the third quarter.

And do you have any specific goals for the water market share behind your water pricing actions?

Bill, we look at the total water market, and we are very committed to growing brand and growing share and doing it through a combination of base water plus the innovation.

Thank you.

Thank you.

Your next question is from Bonnie Herzog of Citigroup.

Good morning, everyone.

Good morning, Bonnie.

I actually have a question on future pricing opportunities in your Frito-Lay North American business.

If you feel you need to do this, what is the best way to take pricing?

Would it be better to take a wholesale list price increase, increase your promotional spending, or possibly a weight-out strategy?

Also, if you could talk through what the impact of a 1% increase in price at FLNA would have on your volume, and would this same relationship hold true in the non-measured channels that?

That would be very helpful.

Well, really, we use all of the tools that you mention, Bonnie; mix, list price, promotional, and weight-out.

We've had a lot of years in experience in trying to balance that but, I would say, at the end of the day, it's still an art.

And we work carefully at trying to keep the value in products.

And, I think, based on the performance so far this year, I feel very comfortable that the team at Frito is got a good handle on how to deal with the pricing.

We -- as I said in one of the earlier calls, we want to make sure, before we take pricing, of any of these types, that we understand what the long-term commodity costs are, so that we don't penalize the consumer and scare them off with pricing that we don't need to take.

So we're very careful with that.

I think the weight-outs that we've taken most recently were well-done.

And, frankly, I don't anticipate, at this time, that we're going to need to take more pricing, but we'll constantly watch that.

As to the effect of 1% price, it really depends on how you take it, Bonnie.

And it's hard to answer that out of context, because if you take it out of list price, it has a different impact than if you take it out of weight-out.

So that question, although it's a very good question, I don't think we can answer it very easily.

Is there a way to put a range around it, give us an idea?

Let us give some thought to it, and we'll come back to you, because I wouldn't want to take a shot at that casually.

We've got different kinds of trade-offs that we use with different tools.

So, again, out of context, it would be difficult to answer that.

All right.

Well, thank you.

Thank you.

Your next question is from Christine Farkas of Merrill Lynch.

Thank you, very much.

A question on your ANM spend increase versus your prior plan, if there are any changes.

Specifically, given your $0.03 of extra earnings this quarter, if we can call it that, as well as your out-look of moderating commodity prices in the second half with some risk to fuel, should we view that additional -- additional gains as being reinvested in the business over and above your ANM prior goals?

Well, broadly speaking, the plans that we have in place right now are plans that we've been working on for long time.

So they're not, in that sense, incremental, and ANM is certainly a part of the investment.

It varies by business, but we haven't substantially increased the ANM investment decisions in the last month or so.

To, I think, you know, Bonnie, when we went -- Christine, when we went into the year, we told that you our operating profit growth this year was going to be 8%, which was a bit lower than what we delivered last year.

And the reason we said it was going to be 8% is because we wanted to step-up our spending in North American beverages, a little increase in ANM and Frito-Lay, and we wanted to remain competitive internationally, because our key beverage competitor was stepping up their investment.

And so, what we're observing mow is in the first half we had very strong results, but in the second half all of the investment that we'd planned is going to kick in.

So the year still looks good at an 8% profit growth, but all the investments we're making are the planned investments.

Okay.

So the language we're hearing around aggressive spending at PBNA or step-up in investment at Quaker and International is already built into your plan from months ago?

It is -- it's not change.

Okay.

That's great.

Built into the plan the beginning of the year, Christine.

Okay.

And I just have a housekeeping follow-up question regarding Frito-Lay North America.

Your volume's up 2%.

Your press release indicated core salty up almost 3%, and macro revenues up in the teens.

What dragged the division down?

That's a great question.

And the most part, the biggest impact on the total volume was the non-core salty new product introductions from last year, which have been discontinued;

Toastables, Crisp-ums, and products like that.

And so that's why you see the total number lower than the salty number.

And within the salty category, we had products like Rolitos, Doritos Rolitos we had last year, which have been discontinued, as well.

So, the base business has been very strong.

And as I said, in the call, the Better-For-You products have been even stronger than that.

Alright.

That's helpful.

Thanks.

Thank you.

One further clarification.

This may open up a series of other questions, but the weight-out also would have affected the volume number.

So on a salty basis, that number, if you wanted to put it on an equivalent basis, would be a -- you'd have to take that into consideration, as well.

Thank you.

Your next question is from John Faucher of JP Morgan.

Yes.

Good morning, everybody.

Indra, a quick question on the cash side, which is, as I look at your cash balance, particularly year-over-year sequentially, it's increased a little bit less sequentially than year-over-year.

You did return a lot of cash to shareholders this quarter but, you know, as you look at that balance in terms of how it's increased, there's been some questions about uses of cash recently, so can you give us some ideas in terms of, you know, why you're carrying the extra high cash balance at this point?

Thanks.

John, as you know, one of the nice problems that we have is that our international business is growing very rapidly and a lot of our cash is being generated overseas.

So a lot of the cash balance that you see on our balance sheet is really the International cash build-up.

In North America, we are borrowing to pay out the higher dividends that we're now paying out, and for share repurchases.

So, that's one of the reasons you're seeing the higher cash balances.

So, at this point, there's no change in our strategy to give back all the cash-flow we generate after Capex in the form of dividends and share repurchases back to all of our shareholders.

So nothing has changed in that strategy.

Okay.

Thank you.

Thank you.

Your next question is from Corey Horsch of Credit Suisse First Boston.

Good morning, everybody.

Just had a quick follow-up on marketing spending and brand investment, given the competitive situation in North America.

Just wondering, longer term, if your competitors focus more on the mix component of net revenue realization as opposed to, you know, taking prices up in carbonated soft drinks, how that affects, if at all, the way the Pepsi system thinks about balancing the portfolio on beverages?

Thank you.

Dawn, you want to answer that?

I think when you look at the beverage growth and the mix of beverage growth across water, non-carbonated, and CSD's going forward, there will be an importance of making sure that we get mix to deliver the right revenue growth.

And in the CSD category, I think it's important that we continue to have rational pricing that supports good system profitability, but that we get that through the right combination of mix and rate.

And in the case of water and non-carbonated beverages, there's a lot of opportunity, as we get into new innovation areas to provide added value to the consumer they'll pay more for.

So we're very much, I guess in answer to your questions, looking at balancing rate and mix across the total beverage portfolio.

And nothing you've heard or seen so far in the market since this investment has ventured in or since your competitor has altered focus slightly, kind of changes your approach or that has caused to you rethink anything?

It's kind of in line with where you already were?

Right, I think you're always going to see short-term fluctuations, but I think you have to take a long-term view of this, and I think most competitors want to make sure there's pricing realization long-term.

Okay.

Thank you.

Quickly I'll just go back to the question that John Faucher asked on the cash build-up.

John, one other point we should make to you is that under the American Jobs Creation Act, as we've said in our release and we've talked about in our -- dealings with all of you over the past few months, we can bring back about $7.5 billion of cash, which is a permanently reinvested earnings internationally, back to the U.S. under the American Jobs Creation Act.

We are scheduled to take a proposal to our board, which is going to meet end of next week, and we'll be back to you with what our board suggests we do.

But that should address the whole issue of International cash build-up.

Thank you.

Your next question is from Filippe Goossens of Credit Suisse First Boston.

Yes.

Thank you.

And, actually, my question is a follow-up on the last comment from Indra on the Jobs Creation Act.

If I look at -- if we assume for a second that you were to propose to the board and the board would accept that you would repatriate the maximum $7.5 billion that you outlined in your press release this morning, and we look at your cash of about, let's say, short of 600 million plus about 3.3 billion in marketable securities with a big portion of that sitting overseas, would it still be fair to assume that you may, potentially, tap the capital markets this year to fund that repatriation?

Oh, it's not may.

We will.

You will?

Okay.

Can you give any order of magnitude, as well as what currency it would potentially be in?

I mean, look, just south of between 7.5 billion and what cash we have, but what currencies we're going to tap and how we're going to bringing back, we're working through the details as we speak.

Okay, great.

Thanks so much, Indra.

Thank you.

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

Good morning, everybody.

Just two questions.

First, how much did Snack Ventures Europe contribute to the Pepsi International numbers -- profit?

Indra?

I think we talked about it beginning of the year.

I think the net increase for the -- just one second.

I'll give you the exact number.

While we're looking for the exact number, if you wanted to look at organic growth, you really have to do the puts and takes, of which SVE is a part, but there are three pieces into that.

We've got a new business in eastern Europe.

We've got the discontinued business in Korea, and the SVE.

And the net of that would be, I think, also important to know.

Most importantly Snacks Venture Europe, both on the volume and revenue side we were already consolidating Snacks Venture Europe into our numbers.

On the profit side, I think we mentioned it on our Q4 call earlier this year, it contributes somewhere between a point and a half and two points to our profit.

But, as Steve said, that gets offset somewhat because the South Korea snacks JV we got out of, and then we, you know, picked up a couple of other assets, which have an impact on the profit of the overall business.

But SVE, between a point and a half and two points.

Okay.

I'm talking the impact on Q2.

Okay, that's great.

And if could you also -- I don't know if you commented on this earlier or not, but your carbonated soft drink business so far in the third quarter, can you talk a little bit about how that's performed and what your market share has been?

Dawn, you want to comment on that?

Well, again, without looking forward, I'd just say a reminder that the part of PBNA that's in the bottling system, volume is reported out at April and May, where our bottlers and the rest of PBNA reports out including through June 11th.

So you have a very short quarter in quarter two.

If you were to add had the volume from June into that, it would have looked like a much better quarter.

Okay, great.

Thank you.

Thank you.

Your next question is is from Eric Katzman of Deutsche Bank.

Good morning, everybody.

Indra, I think you talked about the working capital improvement.

But if you exclude the tax payment of 760 million, I think your working capital usage was up 43% versus a sales increase of 9%.

Can you comment on what's going on there, if my math is correct?

Let's start with the operating working capital measures, because that's the measure you really should use, because the cash buildup, in fact, distorts the picture a little bit.

In terms of working capital measures, which is the DSO, DPO, and the DII, the day sales outstanding are trending in the right direction.

Our days payable outstanding are trending in the right direction.

And as I said, days in inventory are up, but they're up because seasonally they have to be up because we are going into our heavy quarters.

So overall, in terms of our operating working capital metrics, we are doing very, very well.

The issue is is the cash build-up, which gets counted against the current assets, and that's what distorts the number.

Oh, I see.

Okay.

And then, Steve, did you clarify exactly what the weight-outs that you took were in terms of on a percentage basis, like how much that ended up being in terms of price?

I mean, most of the companies that we've been tracking, you know, price increases have probably been on the order of 4 to 5%.

Is that a fair guess as to what you did?

Well, Eric, let me turn it around a little bit and say that the weight-out impact on volume was probably between a half a point and a point on volume.

And, in terms of price, it would be lower than the percentage increase that you just quoted, but I can't give you an exact number.

Okay.

Thank you.

Your next question is from Robert van Brugge of Sanford Bernstein.

Yes.

Good morning.

I have a question about the international beverage strategy.

You continue to do very well here, and traditionally you've been focused on a few core markets for that.

Given your recent success, is there any change in your aspirations for this sentence.

I.e., are you looking to add more markets to your core markets, or are you trying to go for more categories or more market share in the markets that you're in?

Well, certainly going for more share in the markets we're in has been and continues to be our strategy.

And we haven't changed our strategy in terms of market penetration.

We've been focusing on, you know, certain key markets and that continues.

And for purposes of competitive intelligence, it's probably easier just to leave the question at that.

But I would tell you that our strategy that we've been executing in International beverages, as well as snacks, is a long-standing strategy, which we're comfortable with, and we don't see a change in that in the near term.

Okay.

So some of the incremental investment in Pepsi International that you were talking about, that will be both behind snacks as well as behind the beverage business?

Yes.

Yes, the answer is yes.

Okay.

Thanks.

Thank you.

Your next question is from Alec Patterson of RCM.

Good morning.

Was curious, Dawn or Steve, just your impressions of the efficacy of some of the pricing -- promotional pricing couponing coming out of the Coke system and maybe just the perception of how much of an impact it is having on branded beverage restimulation of the category.

Do you see this as working?

Is this something that maybe has a beneficial side to the category?

Well, let me make a comment, then I'll ask Dawn to comment on it.

I think pricing and couponing has a place in the overall marketing mix, but it can't be taken out of context or overly emphasized to have a healthy brand long-term.

As to commenting on the competitors activities, I'd rather leave that to you.

But in terms of our own strategies, we think that we want to use all aspects of the marketing mix.

And from time-to-time, couponing can be effective, and, you know, I go back to a comment that Dawn has said several times, and I think Indra and I have said as well, and that is that the CSD category, we believe, has potential long-term, and it has been under pressure recently for a number of reasons.

But, in my own personal opinion, pricing, upward pricing, has probably had as much impact negatively on that category as anything else.

And so, I think, what you're seeing in some of these tactical activities like couponing is a way to get that balance back to bring some activity back into the category.

But, Dawn, I don't know if you want to add something to that.

Not much, Steve, except to again say that couponing has lots of applications.

I think one of the best uses of couponing is to drive trial of new products, to cross-ref when you've got a strong brand like Pepsi to let them try Sierra Mist.

To get people who are interested in Nutrasweet, to let them try Pepsi ONE.

I think another strategy is to get -- for example, we have a coupon right now on the marketplace across all of our Pepsi diet products because people in the diet category tend to drink more of one brand than in the regular CSD category.

So giving those people an opportunity to buy some of our whole portfolio, enjoy variety within the Pepsi trademark, I think is a good strategic use of a coupon.

And so we have stepped up our investment this year and that includes step-up in couponing but, again, I think appropriately trying to direct it at those marketing strategies that we believe will drive long-term brand value.

And I think, Dawn just talked about cross-refing, and probably our best example of that is Power of One, the use of couponing across our businesses in Power of One.

Probably the most effective couponing activity we've done across all our brands has been in those Power of One activities, where we bring thematic couponing around either an event or day part that really is relevant to the consumer, and that brings them into portfolio of our products on a broader basis.

I guess the last thing I'd say on couponing is that most of the time the most effective advertising with couponing is something that's new and exciting to the consumer.

And that can be in a lot of different ways.

It doesn't have to be in the depth of the coupon as much as in the newness and the uniqueness around which it's executed.

And just generally on the increased spending that you've got planned for the second half of the year, you suggest that this has been in place since the beginning of the year, yet there does seem to be an element of this is somewhat react I have.

That is, it's been cash in the background to respond to competitive activity from the Coke system or whomever, and it seemed to be somewhat discretionary as to when you might use it.

Should we read this as, you haven't really been using it yet and now you're deciding the level of spending has increased competitively and it's time to step up?

Or is this just more discretionary and you're going to spend it as you see fit?

Alec, that's a great question, and if that's the impression you've gotten, let us step back and talk about that because that was not our intention, and it differs by business unit.

But as we put our plans together last year, for various different reasons, we knew that the second half of the year was where we were going to be making incremental investments, incremental in the sense that they weren't investments that had been historically done in the business, and we were going to step into the businesses in the second half.

And let me go through, just walk through the businesses and try to explain that.

We talked about the food business.

We knew that in the second half we had stronger overlaps from last year than we did in the first half.

So being able to step up the media investments in the second half would be a prudent thing to do versus putting in the first half, where we thought the existing calendar and innovation was quite adequate to move the business.

In Frito-Lay, the investments that we're making in Frito-Lay in terms of incremental advertising, are really against specific brand work.

So I mentioned Tostitos being one of them.

That's a campaign that we've been working on for long time and the incremental investment against media we've talked about in several calls here.

Frito has been a business where we haven't done as much pull spending in the past as we plan to do in the future, and I think Irene and her team have been working very hard at putting prudent plans together against that.

So that would be the Frito business.

In International we talked about our three large businesses on the salty side, and the investments we're making there.

Some of those are advertising, some of them are pricing, some of them are innovation, but they all take investments.

And that had been planned for sometime.

And then coming back to beverages, in North America, clearly there's an element, a small element, of opportunistic investment, but the majority of the second half investment was something that we'd had in the plan all along.

And the reason we probably overplayed it in this call is that we didn't want you all to get the first half performance on the bottom line and just double it down for the second half.

And that was clearly what our effort was.

And maybe we've worked too hard at that, and maybe we gave you the wrong impression.

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

Completely consistent with what you said.

I think, even as we went into the year, we made it very clear that this year's operating profit guidance is 8%.

That's what the number was going to be.

We invested against that. we planned innovation in some part of the second -- the first half, some in the second half, but heavy in the second half.

That's how we set the year out.

And I'll be honest with you.

So far, it's going like clockwork, exactly what we've planned.

The only thing that's different is the first half has been even stronger than we anticipated.

Beyond that, 8% for the year we feel very good about.

As every quarter gets under our belt, we feel more confident about our ability to deliver that number in the face of stepped-up competition and a difficult CSD category, so --

And I guess I would also say, and this sounds maybe overly defensive to the question, but I'm glad you raised it, is we've learned over years that if you make quick reactionary investments in any aspect of the marketing mix, more often than not it's poor investment, and that's not what we're doing.

To invest against the big brands that we have in thoughtful ways take months of planning, and that's what we're doing across all of our businesses.

So, I certainly don't want to leave the call with the understanding or the misunderstanding that we're either chasing volume with last-minute investment or that we're totally opportunistically investing, because that would not be a prudent way of managing the business, and that has not been our expectation.

And I guess the last piece I'd say is that, what we want to do is manage, on a consistent basis, the movement of the top line of our Company, because that's the health of the brand.

That's where the consumers interact with us, and we want to make sure that our volume and our revenue are consistently moving quarter-to-quarter.

And it may take different investments from a profit perspective to ensure that happens, because we can't be -- we can't perfectly plan that from a timing perspective.

But we want to make sure that we're constantly keeping pressure in the marketplace to keep the consumer excited.

Dawn, I don't know if you want to add something from the Beverage North America?

That's great, you guys.

I get the message.

Thank you.

Our final question is from Ann Gurkin of Davenport.

Hello.

Just wanted to get some more detail on Gatorade.

I guess the volume up 3% is less than we were looking for.

Is it basically due to the tough comp last year, or is it timing and promotions?

Secondly, I didn't know if Dawn would comment on beverage performance over the July 4th weekend?

Well, the Gatorade number, certainly as a percentage, was way below what we've seen since we've owned the business.

But I would have to tell you that, not to use weather as an excuse, but the weather was definitely not in our favor in the quarter.

We also were going over some heavy comps from last year.

But I will tell that you we've got seven weeks behind us already, and we are very, very comfortable with the -- with the volume that we're seeing in Gatorade.

It's the strongest.

We've broken records every week for the last couple of weeks in key accounts, as well as overall volume at Gatorade.

And as I said, the recent performance is substantially above 20%.

So, as far as Gatorade is concerned we're very, very optimistic about the Gatorade performance for the key selling season, which we're in right now.

I think, Steve, maybe picture the USA Today map.

When it's red, Gatorade does extremely well.

And in Q2, we had a couple of months where it was just not red enough.

The color was showing a lot of coolness around the country, and that impacted some of the volume in Gatorade.

And then, Dawn?

On the 4th of July question, it's too soon to give you a full recap on the 4th of July.

I'll just go back to -- looking at June, our volume growth, we are pleased with.

It shows improving trends across all categories.

And we were pleased with our inventory levels going into the 4th of July weekend.

Thanks.

Thank you.

That does conclude our question-and-answer session.

I would like to hand the floor back over to management for any closing comments.

Well, we want to thank you for your participation today, and we hope that we've given you a good sense of the business.

We're very optimistic about the future and very pleased with the past performance in the first half of the year.

And we thank you for your continued interest in our Company and for participating in today's call.

Have a great day.

Thank you.

This does conclude today's teleconference.

You may now disconnect your line and have a wonderful day.