PEP
#Thank you, <UNK>, and thank you all for joining us this morning
I am pleased to report that our second quarter results were very much in line with our expectations and that we remain on track to meet our full-year 2017 financial goals
For the quarter, while our reported results continue to be impacted by macro volatility and weak currencies, organic revenue was up more than 3% globally, a sequential acceleration from our growth rate in the first quarter
We generated organic revenue growth across both developed and developing and emerging markets, with developed markets up 2% and D&E markets growing 6%
The portfolio generated strong net price realization and core constant currency operating profit grew 7%
Core constant currency EPS grew 13%
Our results reflect the power and durability of our portfolio, its ability to deliver sustainable and well-balanced results, despite ongoing pockets of macro and geopolitical challenges in a number of our key markets around the globe, and in an increasingly dynamic retail and consumer environment
Let's briefly review the performance in the quarter across our sectors, starting with North America where organic revenue grew 2% and core constant currency operating profit was up 4%
Importantly, year to date through the second quarter, we have also generated more U.S
retail sales growth than all other $5 billion-plus manufacturers combined
Frito-Lay North America had another very strong quarter
Volume and organic revenue accelerated sequentially from Q1, as we expected, and results reflected a very good balance of volume growth, net price realization and margin expansion
We feel very good about the business, with innovation, pricing and execution, all on target
We are pleased to report that Frito-Lay alone was the number one contributor to total U.S
food and beverage retail growth by all $5 billion-plus manufacturers through the end of Q2. Similarly, North America Beverages grew organic revenue and core operating profit, but our growth rates were limited in part by adverse channel and subcategory mix in the quarter, as we have seen a lower rate of year-to-date growth in the C-store channel compared to last year and water growth outpace the balance of our business
We are encouraged by continued strength in our [stills] portfolio with good growth in Gatorade, our total water portfolio which benefited from the strong introduction of LIFEWTR, Lipton, and our distribution of Rockstar
In fact, in just five months of sales since its launch in Q1, LIFEWTR has already reached $70 million in retail sales across measured channels, was the top brand contributing to LRB retail sales growth of the second quarter, and is on track to generate approximately $200 million in retail sales on an annualized basis
On the carbonated side, we are encouraged by the performance of Pepsi Zero Sugar, but have more work to do on the carbonated portfolio overall
We will also be allocating a bit more marketing behind the big sparkling brand in the second half
We have strong activation for this summer behind Pepsi Fire and our DEW-S-A program, followed by strong execution behind the NFL as we get to the fall
As we execute our second half plans, we will remain very focused on driving better net price realization and letting our marketing and innovation drive the top line
Quaker Foods North America performance continues to be impacted by broader center-of-stove pressures, but is performing well relative to other large breakfast manufacturers
Going forward, we have powerful programming in place aimed to improve the trajectory of the business
So for example, we have activation behind portable breakfast innovation, namely Breakfast Flats that we launched in 2016 and Breakfast Squares that were launched in the first quarter, and we have just launched a new and first-to-market Overnight Oats Cup in the second quarter to capitalize on the recent and growing consumer trend of preparing chilled oats using a variety of healthy ingredients
Turning to our sectors outside North America, in Latin America we continue to see very challenging macroeconomic conditions, geopolitical instability, and high levels of inflation in key markets, including Brazil and Argentina, which are dampening consumer spending
Within this context, our businesses are performing well
Our largest market in the region, Mexico, encouragingly has been relatively stable and resilient and is performing well, and posted double-digit organic revenue growth in the second quarter
While our core profit performance in the first half of the year was impacted by difficult economic conditions, we expect to see an improvement in core profit growth in the second half as we lap incremental investments from last year and we realize productivity from supply chain initiatives
Similarly, we are experiencing macro challenges in a number of markets throughout our Asia, Middle East and North Africa segment, including the significant currency devaluation in Egypt and the economic impact in a number of markets across the Middle East stemming from persistently low oil prices
Related to these, we are experiencing significant cost inflation in Egypt arising from adverse transaction Forex and we are dealing with the recently imposed carbonated soft drink tax in Saudi Arabia
So we are adjusting our business to address these challenges
We are pricing to cover the increased cost of doing business, we are going more aggressively after productivity to reduce our overall costs, and we continue to transform our beverage portfolio to offer more non-carbonated options and reducing sugar levels across the portfolio
On the other hand, we are encouraged by a number of bright spots in the region, including China where we saw double-digit beverage organic revenue growth and mid single-digit snack organic revenue growth, in markets like Pakistan and Egypt where organic revenue was up double-digits
And finally, turning to Europe and Sub-Sahara Africa, we had very good results across the region, with organic revenue growth in each of our major markets and a sequential acceleration overall
Russia, our largest market in the region, had mid-single-digit organic revenue growth and very strong operating margin improvement
As you saw in the release, our results also benefited from our sale of our minority stake in Britvic
Even excluding this gain, core operating profit was up 19%
So we are very encouraged by the performance in the region and are optimistic about the outlook for the balance of the year
We continue to manage what's in our control and our portfolio products and geographies is working
And so, with half the year behind us and our performance overall in line with our plans and expectations, we remain very much on track to deliver our full year financial target of at least 3% organic revenue growth and 8% core constant currency EPS growth
And we continue to deliver these strong, reliable results even as our industry is undergoing some interesting shifts from multiple angles
Consumer habits and behaviors continue to evolve, some trends like consumers' increasing demand for convenience and variety have been present for decades but are becoming more pronounced, consumer shopping habits are rapidly adapting to evolving and new retail formats, and their lifestyles are increasingly influenced by pervasive social and digital media and mobile technology, and this in turn requires new marketing models that harness the power of digital media and big data in a way that enables us to communicate with consumers on a much more personal and individualized level
Consumers are also seeking more value and benefits from what they purchase and consume
They are also seeking more premium experiences, and at the same time seeking value
And across the spectrum, consumers continue to be interested in health and wellness, but with differing definitions, often not science-based of what this means
Perhaps more pronounced are the changes we are witnessing in retail where the lines are blurring between channels
Brick and mortar retailers are building deep e-commerce capability, pure-play e-commerce is moving into brick-and-mortar, and virtually every channel is melding aspects of grocery, convenience, foodservice, meal kits, prepared meals, and home delivery
So with all this change occurring and at an accelerated pace, we could look upon the spirit in our industry with hesitation and pessimism or with a sense of excitement and optimism
We choose to take the optimistic approach because this period offers a once-in-a-lifetime opportunity to strengthen our business and capture new avenues of growth
We believe we are well-positioned to win in this environment
In fact, we anticipated and prepared for many of the trends we are witnessing today
To begin, we participate in growing categories with products that are well-suited to consumers' continued desire for convenience, on-the-go portability, and snacking, in place of structured meals
Many of our brands occupy the number one or number two spot in their respective categories, giving them the scale to cut through an increasingly cluttered and fragmented media landscape, especially in the digital realm
Our product portfolio has the stretch to continue to evolve with consumer needs
We have the ability to innovate to provide new benefits and value to the consumer in ways that are not only consistent with the brand's equity but in many ways strengthen it
A few examples come to mind
Lipton tea, over the years we have not only added more variety but we have strengthened the brand by introducing increasingly premium offerings, first with Pure Leaf and more recently with the Tea House Collection, resulting in the leading share position we enjoy today
Or Mountain Dew, where over time we have expanded the trademark from traditional green-bottle Dew and Diet Dew to exciting line extensions like Code Red, White Out and Voltage, and our very successful Kickstart lineup
Or Doritos, where our loyal consumers have embraced flavor extensions to the core product and innovations we have taken to foodservice and quick serve restaurants
Or Quaker, where we have provided increasing portability and convenience to a hearty, healthy breakfast through the introduction of Breakfast Squares and Breakfast Flats
Beyond our product advantages, we also have a well-balanced geographic footprint that enables us to weather pockets of macroeconomic volatility
Importantly, we have extremely strong relationships with our retail partners and meaningful presence of scale across all our relevant channels
In each of our five largest markets, comprising approximately 75% of our total net revenue, we are the largest or #2 food and beverage manufacturer based on retail sales
Regardless of channel, our products and brands possess a number of important characteristics that make them highly appealing to our customers
They are often purchased on impulse, which makes them highly incremental and therefore build basket and box size
On promotion, they drive traffic
They are highly complementary to other food and beverage purchases and they have high velocities, which makes them very productive in whatever shelf they occupy, and therefore they are big cash flow generators
These attributes translate to the very foundation of the value we bring to our customers regardless of channel
We deliver sales growth and cash flow for our customers
And our partnership with customers goes well beyond supplying great products
Our deep capabilities, enabled by our scale and years of extensive investment, allow us to work with a strategic partner, delivering value in the areas of supply chain management, consumer and shopper insight, social and digital consumer engagement, research and development, design, data analytics, and e-commerce
In fact, our execution with retailers, leveraging the full breadth of our capabilities, deserves to be named the #1 best-in-class manufacturer in the most recent annual Kantar Retail PoweRanking survey in the United States, and this was further reinforced a few weeks ago when I attended the Consumer Goods Forum in Berlin
In meeting after meeting with our retail partners from around the globe, they expressed how much they value the growth we generate for them
And finally, one of the most compelling reasons for our optimism is our culture
Over decades, we have built and developed a culture that thrives on change
We have the heart of a challenger, a can-do spirit, with a must-do result
We view the evolution of our business, that is products, supply chains, processes, organizations, or business models, as our natural state
Our business today is very different than it was five years ago and we expect it to be very different five years from now
Consider our beverage portfolio transformation that began decades ago when we had declared that we would become a total beverage company, and over the years we have built an enviable portfolio of leading brands across virtually every sub-segment of the beverage category, including Gatorade, Tropicana, Aquafina, Lipton, and Starbucks, through organic introductions, joint ventures and acquisitions
And this transformation continues, as evidenced by our recent introductions of products like LIFEWTR, Lemon Lemon, and IZZE Fusions, and acquisition of KeVita
By having continuing to evolve our supply-chain over the years, as the retail landscape has changed and new technologies have come to market
Our supply chain in Frito-Lay today is very different from the one we operated just a few years ago
For example, our deployment of GES has enabled us to handle more SKUs, fulfill demand with greater speed and accuracy, improve product quality and freshness, and operate more efficiently
With our embrace of performance and purpose, the journey we embarked on more than 10 years ago that has transformed our business to adapt to the changing world around us
We have reduced added sugars, saturated fat and sodium in many of our products, while continuing to expand our lineup of nutritious foods and beverages to meet growing consumer demand
Our product transformation efforts to date have resulted in a portfolio where we now derive approximately 45% of our net revenue from products that we refer to as guilt-free
These products include diet and other beverages that contain 70 calories or less from added sugar per 12-ounce serving and snacks with low levels of sodium and saturated fat, as well as what we call 'everyday nutrition product'
And a full 28 points of the 45 points is made up of what we refer to as 'everyday nutrition', products with positive nutrients like grains, fruits and vegetables, protein, unsweetened tea, and water
We have steadily improved our operational water use and energy efficiency, reducing our packaging and waste, and promoting responsible agricultural practices globally
We have built a workplace that attracts and retains the world's best and brightest
And we intend to continue to make strides in these areas
We have announced even more aggressive product, planet and people goals that we intend to achieve by 2025. Net, we feel very good about where we stand
We have a leading product portfolio, balanced development across channels and geographies, broad capabilities, a robust productivity agenda, a great corporate culture, and excellent talents
These factors and combinations have enabled us to continue to deliver an attractive balance of top line and bottom line growth, and they give us the confidence to lead into an ever-changing environment with a sense of excitement and cautious optimism
With that, let me turn the call over to <UNK>
That was 10 questions, <UNK>
That was 10 questions very wonderfully rolled into one, but we're going to try to answer every one of those
Let me start by saying that I think you are beginning to see the limitations of the syndicated data, because as I mentioned in my script, the channels are beginning to blur between food service, retail, home delivery, restaurants, everything, the channels are beginning to blur
And when you have blurring channels, you now have a shopping occasion being replaced by home delivery or replaced by a meal delivery of kits
So what we have to do is rethink what is the real growth of the marketplace, the food and beverage marketplace, in a much more holistic way
There's no question that the syndicated data showed a slowdown in the overall market I'd say in the first half
Rather than talk about quarter to quarter, let's just talk about the first half
Slightly south of 2% is what we saw in the first half
But I think if you include a much broader definition of the market, I think you're going to see what the traditional growth is, which is population plus some, more in the range of somewhere between 2% and 2.5%
I think that's what you'll see as an overall growth rate
I think we all as manufacturers have to start to rethink how we serve this multiplicity of channels and how we should retool our business models to serve every one of these fragmenting channels
That's the challenge all of us have and we have been looking at that very, very carefully
Now let's talk a little bit about the category weakness
I think, on salty snacks in particular, let me speak to that
I have belief, and we watch volume, revenue and pricing very, very carefully on a weekly basis, I think where the market is today, when we can take pricing, we should take the pricing, and we have been trying to move the portfolio more to premium products, and the good news is that we are actually making progress in Frito-Lay to move the business more to premium products
And so, I'd say, this thing will right itself, we are gaining share overall in the marketplace, we are gaining value share which is really what we are focused on, we are managing the mix very carefully, managing channel mix, product mix very carefully
We feel pretty good about the Frito-Lay performance and where we are moving the portfolio, nudging it towards premium, balancing the value of mainstream part of the portfolio very, very carefully
So we feel good about that
On the beverage side, we've got good price realization, so I feel good about that
Do I have some concerns about our carbonated soft drink business? Not concerns, but I think they have more opportunity, and I think that as we move towards the second half of the year and we sort of fine-tune our calendar, you'll start seeing more activity from us on carbonated soft drinks
On balance, we have good innovation, and I wouldn't say we are concerned, but we are watching it very, very carefully to make sure that everything that we can control, we do right by these businesses
Big businesses, very attractive businesses, we just want to make sure we get our fair share of those businesses
But the key thing is we are going to focus on price realization and let marketing drive the top line
And it's a great tasting product
So, I'm going to let <UNK> get all the answers ready for the 10 questions you asked in operating margin, <UNK>
Let me talk about the changes in channels
We are all figuring it out as we go along
The good news is, our e-commerce business is growing brilliantly
We are doing very, very well
We are not yet ready to talk about it in any significant way
Maybe in the next couple of calls we will start focusing on that
But it's growing really, really nicely
But it's growing with our traditional products and our traditional packaging, if you want to call it that
There is clearly an opportunity for us to think about innovation for e-commerce, which is what we are all focused on
We want to make sure that our snacks are more shippable, not just in click and collect, but more also for delivery, so that the cube efficiency is there
And on beverages, I think there are two issues
One is the cold delivery of the beverages, if consumers so desire ice-cold beverages delivered to them, which I find it hard to believe, but you can never tell
And then how do we make sure that we address this whole delivery of water, because beverages is largely water
So we are looking at meaningful innovation, both in snacks and beverages, in order to address the exploding growth of e-commerce
And with our big brands, I think we are well-positioned
Now let me come to the impulse nature of our products
I think the whole e-commerce area is going to be impulse as you see it in a brick-and-mortar store, which then translates to e-commerce and then becomes part of a replenishment cycle
But then as people stop going to brick-and-mortar and start shopping only on e-commerce, which well could be the Gen-Z, the new I-generation, if you want to call it that, I think the new digital tools can easily afford you the ability to create the impulse experience online
We have seen so many virtual reality tools right now that can actually simulate grocery stores or whatever version of a grocery store you want online, and you can easily navigate the aisles and just with a click shop for whatever you want
So, I think in an interesting way there's infinite possibilities to create impulse all through technology online, and I think as this market matures and evolves, you're going to see a lot of that happening, and we are focused on developing all of these tools ourselves with our e-commerce partners to make sure that we are responsive to them when they so choose to go that way
So with that, let me turn it to <UNK> to give you the [treaties] [ph] on operating margin
And I think, <UNK>, it's fair to say that with the changing marketplace, where there's blurring of retail channels, the consumer preferences changing, the marketing models changing, we have to invest in these new capabilities in order to generate the top line growth we are generating
So, we intend to continue to invest judiciously in these new areas, so we can sustain our top line growth globally
We model out different channel shifts, what could be the pricing implications, we look at analogs from Europe when there were lots of retail disruptions, and then we look at what do we need to do to get innovation-driven pricing, mix-driven pricing, and then what do we need to offset the productivity, how do we need to go deeper on productivity programs
So <UNK>, what we do do is model this out constantly, we look at multiple scenarios, and then we figure out how to get the best blend of top and bottom line growth in a changing retail environment
The good news is that as the retail environment shifts, we just have to retool our model for the retail environment shifts
The market is still growing, that's the good news, and these are huge categories
So, our goal is to capture the growth with a changing environment with our innovation and our big brands
That's why we focus so much on innovation because we believe innovation can actually create consumer demand and get us the price premium, and then we keep investing in our brands, both at the big brand level and the emerging brands like KeVita and Naked, so that we can grow our business on both ends of the spectrum
I don't know about harder, they are different
I think it's different buckets, different areas, some areas that we are comfortable with, some areas where we have to develop new muscle, but that's part of life in our food and beverage industry
I've been in PepsiCo for 23 years and every five years or so there is a brand-new skill we have to develop
And this place is amazingly resilient, we develop the muscle, we hire from the outside when we have to, we retrain, and then we go on
So, I wouldn't say it's getting harder, I'd just say that it's different buckets and we have to put in the work to make sure that we can deliver growth in this new environment
As I said in response to an earlier question, we are looking at how much productivity we need to deliver to offset any price inflation if it happens because of retail disruption
So, we are constantly looking at how we need to balance top line and bottom line growth, and clearly productivity is a major factor in bottom line growth delivery
So we are looking at that
<UNK>, did you want to add anything to that point?
And I think a lot of the new technologies actually allow us to deliver more productivity
We just need to – I think the key thing people have to take away is that in order to deliver productivity downstream, you have to invest upstream
So you have to invest today to get the benefits tomorrow
Benefits don't come out of thin air
And so, what we are doing is investing today to get more productivity downstream
So, first of all, we don't lose the Lipton business even with change of hands
So I would rest assure that we are protected there
On this whole industry outlook, <UNK>, I think you guys on the sell side are much more knowledgeable about industry and industry trends, because you've been following it for such a long time
We actually read your reports to get insights into where you think the industry is going
So I'd rather depend on your opinions here and we'll keep our opinions to ourselves on this one
Thanks <UNK> for the question
First of all, we don't reconcile our data with the scanner data
We just keep running the business and just we keep selling, we keep making sure that our product is on the shelf
Remember, we are high velocity products
So, we know on a weekly basis exactly what we sell and what's being pulled by the consumer
So we have good data on what's happening in the marketplace
I have no idea why the scanner data diverges so much
It's been happening in many markets and I think it reflects some of the limitations of syndicated data and they need to go back and retool it, but we are very comfortable where we are and we are just going to keep running the business this way
So with that, let me thank you for your questions, and to summarize, we are pleased with our results for the first half, we remain on track to deliver our full-year financial targets, and we feel well-positioned to continue to perform well, even in the midst of change and disruption
Thank you very much for joining us this morning and for the confidence you've placed in us with your investment
