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PepsiCo (PEP) Earnings Report: Q1 2016 Conference Call Transcript

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The following PepsiCo (PEP - Get Report) conference call took place on April 18, 2016, 08:00 AM ET. This is a transcript of that earnings call:

Company Participants

  • Jamie Caulfield; PepsiCo, Inc. ; SVP IR
  • Indra Nooyi; PepsiCo, Inc. ; Chairman & CEO
  • Hugh Johnston; PepsiCo, Inc. ; Vice Chairman & CFO

Other Participants

  • Dara Mohsenian; Morgan Stanley; Analyst
  • John Faucher; JPMorgan; Analyst
  • Bryan Spillane; BofA Merrill Lynch; Analyst
  • Bill Marshall; Barclays Capital; Analyst
  • Caroline Levy; CLSA Limited; Analyst
  • Bill Schmitz; Deutsche Bank; Analyst
  • Judy Hong; Goldman Sachs; Analyst
  • Steve Powers; UBS; Analyst
  • Ali Dibadj; Bernstein; Analyst
  • Robert Ottenstein; Evercore ISI; Analyst
  • Kevin Grundy; Jefferies LLC; Analyst

MANAGEMENT DISCUSSION SECTION Operator: Welcome to PepsiCo's first-quarter 2016 earnings conference call. (Operator Instructions) Today's call is being recorded and will be archived at www.pepsico.com. It is now my pleasure to introduce Mr. Jamie Caulfield, Senior Vice President of Investor Relations. Mr. Caulfield, you may begin. Jamie Caulfield (SVP IR): Thank you, Operator. With me today are Indra Nooyi, PepsiCo's Chairman and CEO; and Hugh Johnston, PepsiCo's CFO. We'll lead off today's call with a review of our first-quarter 2016 performance and full-year outlook and then we will move on to Q&A. We've kept our comments brief this morning and intend to conclude the call by 8:45. Before we begin, please take note of our cautionary statement. This conference call includes forward-looking statements, including statements regarding 2016 guidance based on currently available information. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to differ materially from those predicted in such forward-looking statements. Statements made on this conference call should be considered together with cautionary statements and other information contained in today's earnings release and in our most recent periodic reports filed with the SEC. Unless otherwise indicated, all references to EPS and operating profit growth are on a core constant currency basis. All references to free cash flow exclude certain items. In addition, references to organic revenue results in this call exclude the impact of acquisitions and divestitures, structural changes and foreign exchange translation. To find disclosures and reconciliations of non-GAAP measures that we use when discussing PepsiCo's financial results you should refer to the glossary and other attachments to this morning's earnings release and to the investors section of PepsiCo's website under the events and presentations tab. As we discuss today's results, please keep in mind that our first quarter comprises the 12 weeks ended March 19, our North American operations, and it is a short quarter for our international businesses reflecting the two months of January and February for most of our operations outside of North America. Also please take note that we have reclassified certain functional support costs from SG&A to cost of sales, prior-period amounts have also been reclassified and the details are footnoted on pages A1 of the Q1 earnings release. These changes do not impact PepsiCo's overall revenue, operating profit, net income or earnings per share. Now it's my pleasure to introduce Indra Nooyi. Indra Nooyi (Chairman & CEO): Thank you, Jamie. I'm pleased to report that 2016 is off to a good start with very strong operating results in the first quarter. Global snacks organic volume increased by 1.5% and global beverage organic volume increased 3%, the highest rate of quarterly beverage volume growth in three years. We delivered 3.5% organic revenue growth led by high single-digit growth in Latin America and AMENA and 4% growth of Frito-Lay North America. Our five largest segments, Frito-Lay North America, North American Beverages, Latin America, ESSA and AMENA each had both positive organic volume growth and positive net pricing. Core gross margins expanded by 130 basis points and core operating margins expanded by 165 basis points driven by the positive net pricing and continued execution of our productivity agenda including the implementation of our Smart Spending program. Core constant currency operating profit grew 12% and core constant currency EPS grew 11%. It is noteworthy that we delivered these results in a volatile and uncertain macroeconomic environment. Most of the developed world outside the United States is grappling with slow growth. GDP growth in developing and emerging markets is also challenged with many D&E markets experiencing significant political unrest and high unemployment. Key energy producing countries are dealing with significant budgetary gaps and high levels of local inflation in many of these markets are eroding disposable income and dampening consumer spending. It's a difficult environment indeed.


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Despite these macro challenges, we performed well. Our developing and emerging markets businesses grew organic revenue 7% with double-digit growth in China, Saudi Arabia, Egypt and Turkey.

In the developed markets we grew organic revenue by 2% led by performance in the United States where we grew revenue 2.5%. In fact, in the first quarter PepsiCo was once again the largest contributor to food and beverage retail growth in the United States accounting for more growth than the next 17 largest manufacturers combined. We have performed well because our approach to operating in this environment is and has been to execute well against what we can control and to retool our business models and operating system to cope with what we believe could be sustained volatility and uncertainty. And this is really what we're doing. First, we have accelerated our innovation agenda utilizing our proprietary demand spaces framework. This has led to our new products being more incremental and has contributed significantly to our overall organic revenue growth. We have increased the efficiency and effectiveness of new product launches by leveraging our global scale. We are more quickly and effectively lifting and adapting successful product launches from one market to another, driving more rapid expansion of our largest brands as well as our future billion-dollar brands. For example, in the first quarter outside of North America Lipton ready-to-drink tea grew 10%, Mountain Dew grew volume 9%, Gatorade grew 9%, Naked Juice grew 60%, Sunbites grew 42% and Cheetos grew 9%. We have continued to generate strong net price realization, even in a sluggish consumer environment, through enhanced revenue management capabilities and data analytics. We have introduced new price pack combinations tailored to much more targeted shopper and consumer occasions. For example, in North America over the past five years we have shifted approximately 6% of our carbonated soft drink volume/mix from traditional 2 liter and 12 ounce multipack packages to higher-margin, more profitable single-serve and alternative multicelled packages. These efforts have been driving higher net price realization for us and our retail partners. We have also been future proofing our product portfolio, reshaping it to capitalize on consumers' increasing interest in health and wellness. Just to give you an idea, we track two sets of numbers. First, what we view as everyday nutrition which includes products that provide positive nutrients like grains, fruit and vegetables and protein, plus those products that are naturally nutritious like water and unsweetened tea. These products account for almost 25% of our portfolio by revenue. Second, what we view as guilt-free products. These include the everyday nutrition products plus diet beverages and other beverages that are below 70 calories per 12 ounces and snacks with low levels of sodium and saturated fat. Guilt-free products account for approximately 45% of our portfolio by revenue. The growth of our everyday nutrition products which accounts for a quarter of our global net revenue is outpacing the growth of the balance of the portfolio. And we've had a significant amount of activity underway to transform our portfolio. Just to give you a few examples, we've broadened our beverage portfolio to lessen our reliance on colas and today we have the leading noncarbonated beverage portfolio in the United States. In fact, globally just 12% of our revenues comes from trademark Pepsi and less than 25% comes from carbonated soft drinks on a global basis. We have invested in R&D to create advantaged sweetness solutions and lower calorie products and we are aggressively moving our portfolio to package and product combinations with fewer calories. Mountain Dew Kickstart, with just 40 calories per 8 ounces, is a great example of our execution in this area. Now in its third year, Kickstart generated more than $300 million in estimated retail sales in 2015 and posted a 34% volume growth in the first quarter of 2016. We've also been shifting more of our beverage A&M to lower calorie products in order to accelerate growth in strategically advantaged subcategories. And we've increased the nutritional profile of our snacks and foods through the introduction of products like Smartfood Delights which grew volume over 75% in the first quarter; reduced fat Doritos, the top-selling Frito-Lay snack brand in schools, which grew volume 30% in the first quarter; and gluten-free Quaker Oats just to name a few. Net-net we feel pretty good about our portfolio transformation efforts. Next, we are building and investing in new capabilities to win in high-growth channels. To capitalize on increased out-of-home food and beverage consumption we have consolidated our food service resources into one team, enabling us to creatively leverage the breadth of our product portfolio with our customers and consumers.


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In the United States foodservice now represents approximately 14% of our total revenue and the first quarter outpaced the growth of the balance of other channels combined. This year we will be increasing the out-of-home availability of our everyday nutrition products, both snacks and beverages, through the targeted placement of approximately 20,000 Hello Goodness vending machines across North America.

Our advertising and marketing has also become more impactful. First, we have stepped up our level of investment from 5.2% of sales in 2011 to 6.3% of sales in 2015. In the first quarter of 2016 our A&M expense increased by a further 65 basis points as a percentage of sales versus the prior-year quarter. At the same time, we have increased the effectiveness of our A&M investment by shifting more dollars into consumer facing, working A&M and by more effectively integrating social and digital media in our marketing campaigns. We have also accelerated our productivity programs, contributing to consistent core margin expansion and providing investment funding for growth initiatives. Since 2012, we have generated approximately $1 billion of annual productivity savings and we are on pace to do so again this year. In addition, we have fully implemented our zero-based Smart Spending program across the enterprise. We are already seeing significant expense reductions in the areas targeted and our organization is fully mobilized to identify opportunities to drive even greater levels of productivity. And then we stepped up our marketplace execution by working in creative new ways with our retail partners like unique joint execution of sports and entertainment properties, development of new and innovative merchandising and fountain equipment, execution of coordinated consumer promotions and leveraging the combined power of the PepsiCo product portfolio. So for example, with 7-Eleven, Doritos and Super Bowl all turning 50 this year in the first quarter we teamed up to offer consumers NFL experiences and prizes, including a trip to Super Bowl L. When consumers purchased a golden combo of any size, Doritos, Pepsi, Slurpee or grilled item, they could scan their 7-Eleven app to receive a code to unlock prices from teamupforgold.com. At Albertsons we executed a joint promotion across PepsiCo's entire product portfolio in the All for Super Bowl sweepstakes. It was a massive blitz of in-store displays, in-circular advertising and online promotion. When consumers purchase two or more participating products in one transaction they qualified to enter to win $50,000, one of 50 NFLshop.com gift cards...


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