PepsiCo, Inc.

Good morning and welcome to PepsiCo's second quarter 2019 earnings conference call. Your lines have been placed on listen only until the question and answer session. In order to ask a question or make a comment, please press star followed by one on your touchtone phone at any time. You may remove yourself from the queue by pressing the pound key. 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.

Thank you, Operator, and good morning, everyone. I'm joined this morning by PepsiCo's Chairman and CEO, Ramon LaGuarta, and PepsiCo's Vice Chairman and CFO, Hugh Johnston. We'll begin today's call with some brief, prepared comments from Ramon and Hugh, and then I'll open the call up to your questions. Before we begin, please take note of our cautionary statements. We will make forward-looking statements on today's call, including about our plans and 2019 guidance. Forward-looking statements inherently involve risks and uncertainties and reflect our view as of today, and we are under no obligation to update. When discussing our results, we refer to non-GAAP measures, which exclude certain items from reported results. Please refer to today's earnings release and PENQ available on pepsico.com for definitions and reconciliations of non-GAAP measures and additional information regarding our results and for a discussion of factors that could cause actual results to differ materially from forward-looking statements. And now it's my pleasure to introduce Ramon Maguarta.

Thank you, Jamie. Good morning, everyone. Just four things we'd like to highlight before I move on to a brief recap of the operating sector's results. First, we're very pleased with our results for the second quarter. Organic revenue grew 4.5% overall, with each of our six operating sectors contributing to the growth. I believe the solid growth we had in the second quarter is a good indication of the strength of both our product and geographic portfolios, And it also gives us confidence that the plans we share with you at the beginning of the year are being very well executed. Second, we continue to make progress on our productivity agenda and remain on track to achieve a full year productivity target savings. Third, we're on track with our investment priorities, amongst which We've stepped up our brand investments, which is evident in the increase in A&M in the first half of 56 basis points as a percent of net revenue. We invested in advanced data and analytics to enhance our consumer and shopper insights and sharpen the precision of our execution. We invested in increased go-to-market capacity and capability, including routes, other front-line selling resources, and e-commerce. We invested in increased manufacturing capacity with additional lines and plans to support our fastest-growing brands. We invested to drive greater global systems harmonization and standardization. And we took steps to transform our culture to become more effective by being more consumer-centric, nimble, and collaborative. And fourth, we're reaffirming our full-year guidance. So let me move on to the sector's results, starting with PWA North America. FLNA continued to post strong growth in the second quarter, with organic revenue up 5% and solid market performance. We delivered good net revenue growth in our key trademarks, including Lays, Doritos, Cheetos, and Ruffles. In addition, we posted good growth across all channels in the U.S., led by high single-digit growth in convenience and dollar stores. We continue to invest across the business with the aim to drive sustainable, better-than-industry growth, and this includes investing in plant and warehouse capacity, routes, sales technology, enhanced consumer and shopper data and insights, and brand media. To this point, in the second quarter, FLNA's A&M was up high single digits, with investments across our portfolio of brands. And we're pleased to know that Ethylene A was once again the largest contributor to total food and beverage U.S. retail sales growth in the quarter. PepsiCo Beverages North America delivered 2% organic net revenue growth with solid benefit from net price realization. Trademark Pepsi and Trademark Mountain Dew showed sequential volume improvement and our ready-to-drink coffee and water volumes grew in the high and mid-single digits, respectively. A&M's spending was up strong double digits for the quarter. Beyond brand investment, we're also directing investment on innovation to address new category entrants and to drive success in higher growth category segments. And this is evident with innovations like Mountain Dew Game Fuel, Gatorade Zero, and Gatorade Ball 24, live water, bubbly, new variants of Propel, and extensions within our successful Starbucks and Pure Leaf tea lineups. We're encouraged by the steady improvements we've seen in the business, and we believe that as we execute our planned investment agenda, we'll see a return to sustained competitive performance. Rounding out North America, the second quarter was Quaker's strongest quarter of organic revenue growth in three years, with organic revenue up 3%, driven by net price realization and modest volume gains. We've restored brand support across the Quaker portfolio, and we've returned to volume growth in on-demand and ready-to-eat cereals, each of which deliver mid-single-digit volume growth. Now, moving on to international, despite ongoing microeconomic volatility in a number of key markets, and poor weather in parts of Western Europe, each of our international divisions delivered solid organic revenue growth in the second quarter. Notably, developing and emerging market organic revenue increased 8%, driven by particularly good growth in a number of our key markets. Mexico and Russia were up high single digits. Brazil was up more than 20%, in part reflecting the benefit of LAPI in last year's transport strike. China grew strong double digits, and India increased mid-single digits. These results are a reflection of the benefits of increased investments we're making in the business and reinvigorated emphasis on marketplace execution, driving local relevance and local affordability, expanding our global brand portfolio, and leveraging our global capabilities to drive higher per capita consumption and market share gains.

And with this, let me hand it off to Hugh. Thank you, Ramon, and good morning, everyone. I have just a few comments on the balance of year outlook. As Ramon just mentioned, we're reiterating each of the components of our 2019 guidance. Namely, we continue to expect organic revenue growth of 4%, a core effective tax rate of approximately 21%, core constant currency EPS to decline approximately 1%, free cash flow of approximately $5 billion, and total cash returns to shareholders of approximately $8 billion, comprised of dividends of approximately $5 billion and share purchases of approximately $3 billion. As you model out the balance of the year, I call your attention to the fact that the organic revenue growth comparisons get meaningfully more challenging in the second half. And from an EPS perspective, you should consider the following. First, over the balance of the year, we will be lapping gains from various strategic asset sales and we're franchising gains and insurance recoveries. And second, Our pace of planned reinvestments in the business will accelerate over the balance of the year, and you will see this reflected both in core EPS as well as in our operating margin performance. Now we'll open it up for your questions. Operator, we'll take the first question.

Thank you. Once again, in order to ask a question or make a comment, please press star followed by one on your touchtone phone at any time. Your first question comes from the line of Brian Spillane of Bank of America, Merrill Lynch.

Hey, good morning, everyone. Good morning. Ramon, I guess kind of stepping back, you've had now a half a year of this, you know, stepped-up investment. And I think if we look at the organic sales, the composition of organic sales, particularly in North America, it's a little bit more price-heavy and less volume. So I guess... Two questions around that. One, do you think that the – is the investment allowing for maybe more pricing and mix than maybe existed previously? And second, you know, would you expect that we'd start to see maybe more of a pickup in volume or demand, you know, as more of these marketing initiatives, you know, get into the market through the balance of the year?

Yeah. Morning, Brian. Yeah. Listen, we're seeing – balanced growth in the U.S. and very rational pricing in our categories, both in snacks and beverages. Last year, remember, we had higher commodity inflation, so I think that's being reflected a little bit in the pricing this year. But nevertheless, what we're trying to do is trying to understand much better the consumer, trying to understand the different locations the consumer is going into our categories and maximize, obviously, the the opportunities for revenue in each one of those occasions. We're investing a lot in net revenue management across the company, and that's translating into, I would say, a better mix management, channel management, transaction per unit management, and that's what you should be seeing in the future as well. The most important thing from the investor point of view is we're seeing very rational pricing across the industry, and everybody's trying to generate value by investing in brands, improving distribution, connecting better with consumers versus using price as the only lever of attracting consumers to your brand. So I think it's a pretty powerful, good situation for our categories, I would say.

Our next question comes from the line of Dara Mosinian of Morgan Stanley.

Hey, good morning, guys. Hi. So just to get a bit more granularity on the pricing, we've obviously seen Frito-Lay North America, the balance has tilted much more towards pricing recently with the strong organic sales growth over the last few quarters. So can you give us a little more granularity on what specifically has been driving that, and should we expect more of a balance going forward between pricing and volume? And then also on the beverage side, Obviously, very strong pricing the last few quarters post the fall increase. You just commented that the competitive environment is pretty rational. But just any thoughts on pricing potential in NAB when you cycle those increases in the fall would be helpful. Thanks.

I would say, and Hugh will add to my comments, but what we're seeing in the industry is a trend towards smaller packs. So consumers are somehow either – the size of the household or the particular occasions where they're consuming our products, consumers are moving to smaller packs. And if you recall when we talked about some of our investments in the past, in the past call, we said we're going to put additional capacity because we're seeing that the consumer is moving to smaller packs and some of our capacity is under, you know, there's some bottlenecks in our capacity because of that, right? As the consumer moves into smaller packs, you realize more pricing. Price per kilo is better. Price per liter is better. The second trend is consumers are looking for higher value products, so more functional, more they're looking for more benefits in the consumption of our categories, be it snacks or beverages. And that tends to be also higher price per liter, price per kilo. So I think you will continue to see those trends going forward in our categories. especially in more developed markets. In developing markets, it's a bit of a different game where you have to be very mindful of the price points and the affordability lenses. So if you cross certain price points, clearly your products become out of reach for a lot of consumers. But in developed markets, we see smaller packs and more functional benefits driving what I would say, you know, positive pricing environment. Then also we see more consumption inconvenience channels, channels where consumers are willing to – be a bit less price sensitive, and they pay more for every transaction. So those are trends that you could see as positive trends for the category. I don't know if you do.

Yeah, I totally agree with what you're going to say. A lot of those same things. The only small pieces I would add to it, number one, Dara, in particular with Frito-Lay, Sabra, where we record the volume, but we don't capture the revenue. We only pick it up in equity income. that was about a one-point drag on Frito-Lay's volume. So if you take that out, then Frito-Lay's volume to revenue looks a little bit closer, obviously. And then number two, as Ramon said, I think in developed markets, we probably can expect a couple of points of visual and then a couple of points of consumer-driven mix that will enable us to get pricing in the future. So that, I think, is a reasonable expectation going forward.

Our next question comes from the line of Ali Debaj of Bernstein.

Hey, guys. So I just want to go back to the investments that you've been making now over the past six months and where you expect that to appear in the top line. You know, is it rate? Is it mix? Is it volume? Ramon, I appreciate your commentary in the first question about price rationality in the marketplace, certainly. but the incrementality of the investment I would have imagined would like to show up in one of the top line drivers, and we're not quite seeing it yet. So just trying to understand how you think about the investment and where it's supposed to appear, the ROI of that, and whether you're adjusting anything as it doesn't look like it's actually showing up in your particular results in terms of incremental investment. And in particular, I'm talking about PB&A.

Okay, Ali, hi, good morning. I won't go into very specifics for each one of the business. What I'll tell you is the philosophy behind these investments. We're trying to have a very high growth, sustained high growth company going forward. I think we have accelerated clearly from the 2%, 3% sustained 4% to 5% growth. Our ambition is to stay within those parameters, as we said, the 4% to 6% top line growth. And that would require multiple layers of investment across multiple parts of the business, right? So if you think what we've been doing, we've been investing in what you could call more short-term levers of acceleration, whether there be new routes in the market, so more selling capacity, or improving some of our warehousing bottlenecks that we had in some of our businesses because of high growth, or some of the investments we're putting now in capacity because, you know, really the demand is quite high for some of our technologies. So that you will see reflected. It is being reflected. I mean, you know, if you see 308, 4.5% growth or, you know, acceleration in a lot of the water brands in PB&A or some of the coffees or whatever, I mean, it is being reflected. But the big idea, I think, for us and the philosophy of how we're investing and we're trying to run the company is, is how do we keep investing in capabilities that will give us that 4.5% or 5% or 4%, like between the 4% and 6% going forward on a sustained basis, and not only the U.S., but really across the company. And those have to do with new capabilities and insights and how do we digitalize the company and how do we, what we call precision at scale, so how do we execute our portfolios in every store with the right level of insights and precision, and we have closed loops. on execution so that our people can execute consistently at those high levels? How do we continue to innovate in new platforms and have the right amount of resources to invest in new platforms versus taking money from the core and giving to those new platforms? So that is the philosophy, and that's what we're doing. And to tell you the truth, we're pretty happy with the way the business is responding, the way we're seeing our market share evolving in our key markets and markets to be in the future. So, you know, I think we feel pretty good. And the investment will come in all the different areas that I told you. But with this idea of sustained, very sustained high performance top line, that will be the big driver of value for you guys as shareholders of the company.

Our next question comes from the line of Judy Hong of Goldman Sachs.

Thank you. Good morning. So, Ramon, I think you cited improvement in NAB, particularly around the Pepsi trademark and Mountain Dew, but I guess one area that's still somewhat soft is Gatorade. So maybe from your perspective, if you can talk a little bit about what you're seeing from a Gatorade standpoint. Obviously, you have innovation around the trademark with the Bolt 24. So how does that kind of fit into the strategy and when you think that we should see some more tangible improvement on that brand? Thank you.

Happy. Good morning. Gatorade is clearly a big brand for us and one that is very solid with the consumer. All the metrics on the brand are fantastic in terms of consumer engagement and consumer brand equity in all dimensions is very strong. Now, what we're doing is innovate against that umbrella. The big innovation, I mean, you mentioned Bolt, but the big innovation is being Gatorade Zero, right? So with Gatorade Zero, we've been able to expand the consumer base of the brand to some consumers that actually were athletes, but they put a lot of, I guess, emphasis on sugar, and therefore they left some of the occasions that they were consuming the brand to move into other opportunities. So now with Gatorade Zero, we're seeing that we're expanding again the consumer base of the brand, and that's going to be very, very incremental for us going forward. We're seeing the incrementality for the category. We're seeing the incrementality for the brand. You know, Gatorade Zero is already the number one zero sports drink in the country by quite a distance, I would say. And we see every week the velocity of the brand improving. So I think that this is a brand that will be very big for us. Now, Propel is another big opportunity for us in sports drink and sports hydration. And we see Propel growing also double-digit consistently for the last few years. It's a brand intended for what we call more casual exercisers, and we're trying to give them a good combination of hydration with lower calories. That's working very well. Now we're adding vitamins and some other positive functionality. And then we have Bolt. Ball 24 is a new platform for us. It's going to be a functional platform trying to scale into the athlete off the field. I think the consumption is going to be off the field. We're trying to give hydration to the athlete during the day with functional benefits that are all natural. Now Ball 24 is It's watermelon water plus sea salt. That's how the consumer will get its electrolytes. And then we're adding some vitamins for antioxidants and whatever. And you will see more innovation coming under that platform. There will be off-the-field functionality for the core athlete. We're very positive about the image, the functionality, the brand that we can create around Bolt. And it's going to be one more example of how Gatorade understands consumers and continues to innovate against all the needs of consumers in the sports arena. So we're very positive about the continued share of market development that we have in this segment and how we'll be able to grow the category, which is at the end our biggest responsibility as leader of the category.

Your next question comes from Lauren Lieberman of Barclays. Great.

Thanks. Good morning. I was hoping we could talk a little bit about the international strategy. So, Ramon, you've talked about sort of this like challenger stronghold battleground framework for thinking about markets. I was just hoping you could maybe shed a little bit more light on kind of the investment priorities, whether you want to talk about by geography, by category. And do you think kind of the game changer for you in accelerating performance or market share performance is about Is it more about innovation or is it more about capabilities and execution? Thanks.

Okay. Listen, we see international as a huge growth opportunity for this company long term. And I think we've been growing international two to three times the U.S. growth for the last few years. I think that should continue in the future when you see the per caps of both our snacks and our beverage categories in the U.S. you know, around the world and the U.S. We see a lot of opportunities in snacks by moving unpackaged to packaged. That's a huge trend. We're seeing that our snacks business benefits a lot by urbanization, and as we see people moving into big cities and developing markets, that's a huge opportunity. We have a very good playbook on how we develop per caps of our snacks business. I think we've We keep codifying that better and better, and we have a very, I think, quite advantage playbook, and we're demonstrating that in many markets around the world. So you should see us continue to invest in our snacks business internationally, and that should be a big engine of growth for us. When you go to the beverage category, the same principles in terms of, you know, how big is the growth opportunity as consumers are moving from, I would say... non-commercial liquids to more commercial liquids everywhere in the world. And the nuance in our strategy is obviously we have another competitor that is trying to develop the category with us. And then we have to be smart where we have a higher growth share position versus a medium share position versus a low share position. And our studies need to change, obviously. It doesn't mean that we're not going to aspire to gain share in every single market around the world, but the tools we use and the number of complexities we choose to add to the business will be different depending on the market position we play in every market. So that's the nuance between the beverages and the snacks business. You should see international as a huge growth opportunity for us globally for many, many years to come. And I think we're realizing, you see the numbers that we're posting every quarter, and they show both the top line and the bottom line opportunity that that has for PepsiCo going forward.

Your next question comes from the line of Steve Powers of Deutsche Bank.

Great, thanks. So, Ramon, maybe to build on some of what you said, I think in response to Ali's question, I just wanted to step back and validate your confidence in being able to resume your your long-term algorithm come 2020, that 4% to 6% top line, 20 to 30 basis points margin improvement formula. Because despite the first half investments, your guidance, as Hugh highlighted in his remarks, seems to allow for some deceleration in the back half on the tougher comps. So I guess I'm first trying to understand how confident you are in your ability to maintain first half top line momentum, not only in the back half, but out to 2020 and beyond. And then secondly, to the extent you are able to sustain or accelerate the top line from here, do you see all businesses now being in a position to contribute to necessary margin improvement come 2020, or will certain businesses require another year of more investment beyond 2019? Thanks.

I think obviously we stay true to the long-term guidance that we have. gave a few months ago, right, like five or six months ago. We thought very carefully about that framework for growth, and we obviously are seeing that we're capable of delivering that, and we have the portfolio of categories and the portfolio of geographies that allow us to deliver that on a sustained basis, assuming that we make the right choices around productivity and reinvestments and we make the right choices on where we put this money for reinvestment, the capabilities we're building and where we're planning to innovate. I think we stay true to that long-term framework. Remember when we talked about the reinvestment year for 2019, we said the first, we did a few things, right, in the process. First, we looked at existing budgets and we tried to, you know, reallocate those budgets into the you know, the areas that will give us a better return. So that has been internal. Second, we said we're going to really double down on our productivity, and that productivity will be reinvested for growth. And we're doing that in the sense that our productivity is quite strong and we're reinvesting. And third, we said we probably need a year of additional reinvestments that would, you know, would put a solid foundation for the years to come, whether it is in A&M, whether it is in some of the other capabilities we talked about or capacities in terms of manufacturing or supply chain. So we're doing all that. With that, we feel pretty good about the future. Yes, the company, as you see in many of our industry, we need to keep investing to transforming ourselves, right? So this is, I think, a never-ending story for the future in terms of systems, in terms of new technologies in terms of adding new brands. So there will continue to be additional investment needs in the company going forward. I think we can fund most of them with our productivity efforts and reallocate existing budgets, which in a company of our size, we can make a lot of discretionary decisions on water priorities year after year. So I don't know if you have anything else to add, but that's how we see as a management team the the following three, four years.

Right. I agree with that. And, Steve, just to add a little bit to it, as Ramon mentioned, we said we expect to be back on algorithm come 2020. You know, as a management team, we've been pretty disciplined about talking about next year in February when we get to next year. So I think with the context Ramon's given you, we'll talk about it in more details next February.

Our next question comes from the line of Andrea Teixeira of JPMorgan.

Thanks. Good morning. I have a follow-up and then a margin question. So can you comment on the state of the consumer in the U.S.? As I alluded before, the results this morning have been supportive, but the scanner data has been softer as of late. Is this just the timing or weather-related, or are you seeing the consumer a bit more cautious? And on the gross margin, Hugh, you had called out the timing of commodities pressures in the first quarter earnings and into the second quarter, but the gross margin still expanded well. So have we cycled most of the pressures? Thank you.

Morning, Andrea. Two comments on the consumer, and then Hugh can talk on the gross margin. We're seeing in our snacks business, micro snacks, pretty healthy growth. We're seeing good acceleration versus previous years. The number of occasions are going up. The price per occasion is going nicely, as you saw. And we're capturing above fair share of that growth as a company. So these snacks, I see a lot of good tailwinds. In terms of beverages, It's been a little bit erratic and quite linked to weather, actually. So we've seen, if you take the Q2, the second quarter, we had a fantastic April, but then somehow a lower May and June from the scans point of view because the weather has been, you know, quite, you know, wet and cold. And that obviously impacts some parts of the economy. of the category, especially the hydration-related parts of the business. We're seeing it coming back. So it's good. We see a healthy consumer, a consumer where price elasticities are good. So we cannot see any signals that tells us the consumer is slowing down, at least in our categories, which are low-priced, quite routine categories that are very well penetrated, very high penetrated across all the U.S.

Yeah, and then on gross margins, Andre, yeah, you're right. I mentioned in the last call, I think, that the tougher comparisons were in the first half. As you know, on commodities, we tend to lock about six to nine months out, so we've got high visibility into the back half, and the commodities comparisons in the back half get a little bit easier.

Our next question comes from the line of Kamal Gajrawala of Credit Suisse.

Hey, good morning, everybody. Ramon, you mentioned on several occasions the effective mix, whether premium products, channel mix, pack sizes, all of which sound like long-term trends. Can you give us a bit of a read on how much mix contributed in this quarter? And then also, given that's where it seems like much of the CapEx is going and where your capabilities are expanding, how we should maybe Think about mix as part of your algorithm longer term.

Yeah, come on, too. I'm happy to comment on that. Obviously, it moves around quite a bit depending on, you know, which portion of the year we're in, which businesses are doing well. But it's probably been, on average, contributing about a point.

If you think about some of the capabilities we're trying to build for the company, and we're not the only ones in this consumer goods space, building this capability is net revenue management. Net revenue management is a combination of insights, analytics, and ability to manage channels and consumer innovation and branding. And that is a capability we're going to keep evolving, right? Because the The likelihood of consumers willing to pay more for the same thing, it's going to reduce, right, going forward. So we need to be able to give the consumer much more value through different ways, and that's a capability we are, you know, I think we're good at, we're going to get better at, and the fact that we tend to control our execution all the way to the consumer in many channels, I think that gives us a competitive advantage going forward.

Our next question comes from the line of Nick Modi of RBC.

Yeah, thanks. Good morning, everyone. Ramon, maybe you can just give us a state of the union on the NAB reorganization. Any early learnings, any hiccups, anything you can share on that would be helpful. Thank you.

Yeah, that's good. Listen, this is a – thank you for asking. This is going to be, I think, a factor to our – continued sustained performance in the future in NAB. I think the fact that we're able to understand the U.S. market as one full market but then able to segment it into pieces and execute with local relevance, it's going to be, I think, a driver of growth for us and sustained growth and for us to be better serving our customers in a much more nuanced way. So that was the intention. As any large restructuring, you're dealing with people issues, right? I've seen moving families, location to location, all that. I think that's pretty much behind now during the summertime. Most of the families will move and we'll have everybody in place and ready to execute, full mind. You know, obviously, I think we started in March. Now it's July, so we've had three, four months of a little bit of transition, I would say, in the business. I think the management has done a great job in terms of, you know, working diligently to get people in place and make sure that the employees feel well-treated by the company, and I think we're there. We should see the benefits of what this organization does. they should deliver in the second half of the year. But most importantly, this is a move we're making for the future. So, you know, in terms of distribution in the more capillary parts of the business, in terms of how do we serve regional customers, how do we segment our consumer strategies depending on our market positions in the different states, All those capabilities that we didn't have so much in the past should be reflected in the new organization. We're feeling good. As always, it's been a process of people management and talent management. As you can imagine, this is a lot of people, but it's behind us now.

Our next question comes from Bonnie Herzog of Wells Fargo.

All right. Thank you. Good morning. I was hoping you could update us on SodaStream and some of your initiatives around reducing or even eliminating packaging. And then are there any examples beyond SodaStream to which you can point where you're actively working, again, to eliminate packaging? Thanks.

Yeah. Yes. Bonnie, good morning. SodaStream is doing very well, actually. I mean, it's exceeding our expectations in terms of the – the growth potential, and the growth execution. So we're feeling good. We're understanding more about this platform. We're starting to put more of the PepsiCo capabilities against the Southern Stream business, especially around flavors and around some of the consumer experience with flavors, which I think we're under-optimized. direct-to-consumer opportunities. So we're trying to insert some capabilities into SolarStream, but we're running it as a separate business that should be agile and nimble and going after actually disrupting the bottle business. And that's the strategy, and that is how we want to run this business going forward. In terms of how we're looking at the plastic reduction, plastic waste reduction, A couple of things. Obviously, SolarStream is a big one for us, and we made some commitments recently in the U.S., and we continue to make commitments across the world in terms of what we did in the U.S. A lot of you read it recently. Live water will be 100% recycled brand, recycled PET brand. We'll have no plastics on bubbly, and we're going to be testing aquafina in cans in some parts of the U.S., mostly the West Coast. We made a commitment in the European Union that we'll be 50% recycled by 2030. I think it is. We're also exploring some circular waste management opportunities with our snacks bags in Europe, especially in the U.K., and also in India. So we're really exploring a lot of the physical circularity and making some commitments on which packaging solutions we'll use. Long term, obviously, we have efforts in the – chemical recycling and new materials and alliances with other players in the value chain of chemical industry and the collection industry and some of our partners in the brand business, competitors and not competitors, where we're trying to make a difference in ingredient and material solutions, chemical recycling, collection systems, everything else to try to minimize this plastic going into waste. versus plastic coming back into our systems and us being able to provide the consumers with what I think are very affordable and functional solutions, but they don't go to waste. So that's the principle.

Your next question comes from Kevin Grundy of Jefferies.

Thanks. Good morning. Ramon, I had a question on a couple of brands in North America beverages. So Mountain Dew, which has clearly been an area of focus, but the brand continues to lose some share based on what we see in the syndicated data. Can you give us an update there on your strategy to stabilize the share trends? And then maybe you could just briefly touch on Bubbly, which has done quite well, but the distribution has ramped up here, and then you've spent some money behind advertising. Maybe talk about how you see the opportunity for that brand now with distribution looking rather full. Thanks.

Yeah, thank you. You're right on the two diagnostics. I think we have an opportunity in Mountain Dew to recover share, and we have a huge opportunity ahead of us in bubbly in creating a whole new category of beverages. On Dew, we tried to approach. We had to work on Pepsi. We had to work on Mountain Dew. We had to work on Gatorade. I think we're feeling good about Pepsi. We're feeling good about Gatorade. Now we're going fully into a mountain to investments. We're ramped up A&M. Started in April, May. We're quite heavy across the summer and then Q4. We have a lot of innovation as well that should help the core new consumer to have more options in what is a high loyalty brand. We have Next to Mountain Dew, there is the energy category, right? So we're trying to move you into the energy category in small steps. Kickstart was one that we did. Kickstart is, you know, was a great platform. It's, you know, it decreased a little bit. It's starting to go up again. That should solidify Mountain Dew. And then we just launched Mountain Dew AMP Game Fuel to to put one foot into the energy category with a differentiated position and more towards the gaming and that kind of demand opportunity. It is doing very well. We plan to continue to innovate in that segment. The numbers you see for Mountain Dew do not include game fuel. It is part of the brand, but it's not in all your information systems. It doesn't show up as part of the new brand. But that's how we see the brand growing, you know, investing in the core, due consumer, very loyal, giving them their preferred product in non-sugar, in sugar options, you know, innovating in flavors in due, and then moving due slowly into other spaces where, you know, we think the brand has a role to play, and I think we're able to formulate products that will be very competitive in that space as well. Sorry, on bubbly products. we're super happy, really, with this opportunity. And Sparking Water has always been underdeveloped in the U.S. if you compare with some of the European markets, and we thought there was a big opportunity there. I think the R&D team did an amazing job. We have a very good product, and we see that by the levels of repeat and loyalty we're creating with some of those flavors. I think the personality of the brand is fun, is unique, It's modern. It's young. So the consumers are coming back to bubbly. Bubbly has double velocity. I mean, really, it's double velocity per point of distribution in the last three, four months after the Super Bowl with this new advertising. I agree with you that there's a lot of distribution opportunities yet, and it takes a while for our partners, our retailer partners to – give these brands that are growing so fast the right space in the store. Obviously, there's a lot of dialogues with our partners, retail partners, to expand bubbly space. So we see this brand as a brand of the future. We're going to be innovating in this brand, not only flavors but other occasions that I think we can attack. You're going to see mini cans. You're going to see larger cans. It's going to be an all-plastic brand. I think that is a very good positioning that we can have. So this brand going forward for the modern consumer, the millennial, and the younger mother that I think is adopting this brand for her kids. So we're feeling very good about this brand. This could be one of our next $1 billion brands. That's our goal with the NAB team, and they're executing every step of the way with a lot of precision. So we're very, very happy with this new brand in our portfolio.

Your next question comes from the line of Robert Ottenstein of ISI.

Great. Thank you very much. Ramon, in your opening comments, you talked about evolving the culture of the company. I'm wondering if you could give us a little bit more granularity on what that means, perhaps talk about what you saw in the culture as you were there and took the helm. what you liked about it, what you thought needed changing, and then more specifically, how you're implementing those changes, how they may be reinforced with your incentive programs.

Thank you. Thanks. Great question. I think we're convinced that the culture will be a competitive advantage for us going forward, and that's why the whole management team is spending a lot of time in first defining a set of leadership behaviors that we think are core, to PepsiCo, and we call this the PepsiCo way, and now rolling out those behaviors across the company in every geography. And it's been quite exciting to go around the company and see how fast the organization is embracing these behaviors, and it makes us very optimistic about the future. The behaviors, there's a few that are critical for you as investors, and it should empower performance. One of them is being very consumer-centric. So we want to have an organization that creates a lot of values, a lot of value for the company and for the investors by understanding the consumer with a lot of details, making decisions around innovation, but not only innovation, but the whole management of the company around the consumer. I think long-term that's going to give us a lot of differentiation and market share. Then there's a few values around how – about speed and – and ownership, which I think it's, if you think about large companies of our scale and, you know, the competitors we have in the marketplace, we need to act with speed and we need to act as owners, right? And that's something that you can lose over time because, you know, sometimes we become more internal than we should and we become more process-driven than we should. So what we're trying to do is make sure that each one of our employees feels that he is an owner of the company and that he is expected to act with empowerment and speed and simplicity. And we're trying to simplify our processes and allow people to really behave as owners in the company. Of course, integrity is core to our values, and we operate in so many countries around the world. That has to be core to the way we operate. And then there's values around raising, you know, talent and diversity. And I would think that long-term for companies like ours, you know, bringing in new capabilities and making sure the new generations feel very good in our company. We create the environment for them to thrive. It's critical. So we're trying to also put talent and diversity at the center of those leadership behaviors and how we recruit the best and how we make sure that they feel that this is a place where they can make a difference and they can voice their opinions and challenge the status quo and make sure that that is part of how we run the business, right, with diversity and making sure that everyone has a point of view and everyone feels that they have the right to have that point of view heard by everybody around the company. Of course, then we can only do a few things and we will have to make the choices and everything else, but But that culture is critical. So speed and ownership, talent and diversity and opinion, consumer centricity, integrity, those are some of the values that we want to reinforce. It's not that we didn't have it, but we think it's worth reemphasizing with the final output being a great company that is focused on growth and creates value with winning in the marketplace. Of course, we don't want to lose the purpose. I think purpose is critical in any company, in any organization, in any individual today. And especially if you talk to new generations, they feel very strong about making a difference in the planet. So we want to make sure that purpose is part of our commercial strategy, that our brands talk purpose, that our commercial teams talk about purpose, and our Our organizations are very well-rooted in every community, making a difference in how people live around us. Those are the different components of the culture change that we're making. As I said, I feel extremely excited because everybody is embracing this. Obviously, we're traveling a lot around the world, and I see how people are talking about those behaviors and that language very consistently across the company.

Our next question comes from Laurent Grandet of Guggenheim.

Yes, good morning, Ramon and you, and thanks for the opportunity. Building on Laurent's question, I'd like to understand how you see an international brand or platform expansion in beverages specifically. So we were surprised by the launch of the Lavazza lineup in the U.K. Without the departure from a potential Starbucks partnership outside of the Americas or the U.C., both brands could potentially coexist in the future. So basically how your coffee strategy is evolving here. And then on Gatorade, we keep talking about the U.S., but I'd like to understand your plan to make the brand more available outside of the U.S., please. Thank you.

Great. Hi, Laurent. So two things. Obviously, Starbucks is our very strong partner for many years, and the value of that relationship is super important. you know, I would say we're very aligned. We're building, I think, a very powerful business together in the U.S. and some other parts of the world. Unfortunately, in Europe, Starbucks had some previous relationships, and that's why, you know, if we wanted to compete in the coffee space, we needed to find another partner, and that's Labadza. We chose Labadza. So there's nothing in terms of... I would say the relationship, on the contrary, is an extremely powerful relationship where we're creating a lot of value for both companies. The European piece is a bit of a separate relationship because of existing contracts, et cetera. In terms of the Gatorade brand, this is really a global brand in terms of consumer understanding and consumer awareness. we just made some priorities in the past of Latin America, U.S., and China being the core markets where we want to build this brand. In markets like Western Europe or Eastern Europe, we're choosing much more of an e-commerce type of way to develop the brand, so a lighter investment, if you wish. But it's a big priority for us, and it's a brand that we think we have a competitive advantage in, in terms of the product solutions, and clearly the brand is very well recognized and it's very well perceived by many consumers around the world because of the sport, you know, the assets that we have in the sports world, and obviously people watch TV everywhere, right? So they can see the soccer, the football, the basketball, any of our assets, and the brand continues to develop. So you should see us both working on coffee and sports around the world.

Our next question comes from Caroline Levy of Macquarie. Good morning, and thank you very much.

Just very briefly, if you could touch on what you're seeing in terms of the macros. You mentioned Brazil being very strong and some other countries. Is the Brazil really just a one-time comp issue? But more importantly was a more strategic question around price mix realization because historically in the world of bottling or where you own distribution, price mix is more valuable than volume because there's less incremental cost associated with that than in delivering new volume. And so I'm just wondering if over time that holds true, that your margins will improve as a function of price mix improving given that you own your distribution.

Gotcha. Yeah, Caroline, it's Hugh. In general, I think that the macros down in Brazil are slowly improving. We talked about the fact that we were lapping some extraordinary things, which made for a very high growth rate in the quarter in Brazil. But I do think we see the macros there slowly improving. In addition to that, we are using the playbook that Ramon referred to in terms of building out our salty snack business and being very methodical about it. It's a business that I've been around for a long time and has gone through multiple cycles, but I really do feel that with the leadership we have, both at the sector level as well as at the business unit level, we've got the right people to execute and build that business in a very solid foundational brick-by-brick way to build another good profit platform for PepsiCo. As regards to the specifics of the beverage business, I think our interests with the bottler in that market are very well aligned. So, We benefit both from volume and from price mix, and I expect we'll continue to work closely with them to improve what's obviously a relatively small beverage business for us.

Your next question comes from Bill Chappell of SunTrust.

Thanks. Good morning. Good morning. Good morning. A question on the energy category. I mean, I get and I think most do that you're not interested in buying some of the smaller brands that are out there. But I'm surprised that we haven't heard or seen something about a Pepsi energy drink. And I understand that Mountain Dew and you have other kind of plays in the energy market. But is there something that on the cola flavor, you don't think that plays as well in the energy market or you don't see as much opportunity, be it outside the U.S. for the Pepsi brand and other flavors for the Pepsi brand? Just trying to understand, especially with what Coke has said and kind of their – optimism about the Coke energy product, you know, why we haven't seen a Pepsi energy product?

Yeah, good question. The energy is clearly a growing market across the world, and we think that the consumer will continue to ask for products that give them that functionality of higher energy or boost. We're approaching this from many angles, right? from the sports, from obviously the energy category itself. We're capturing some of those occasions already now. In the case of the U.S. energy, we have a pretty good partner for many years, which is Rockstar being our partner, and we've been playing in this segment for a few years together, and it's working also in some international markets. So, you know, we plan, obviously, to continue that relationship, keep innovating, and see how we can accelerate our participation in that growth category. With regards to Pepsi Energy or Coke Energy, I mean, those are, you know, we're all trying, I think, as a strategy to make our global brands play in more spaces, right? So we're trying to do that with Lays, or we're trying to do that with Doritos, or we're trying to do that with Pepsi. Pepsi actually... If you see our growth internationally, it's a lot on flavors, Pepsi flavors. It's a lot on Pepsi non-sugar, zero, and obviously Pepsi regular in multiple formats. I think we will keep expanding Pepsi into other spaces, whether it's energy or some other spaces. You will see when we get to the market. If you think about the core energy consumer, It's looking for something different than what Brand Coke or Brand Pepsi can offer. I'm not saying that there will not be occasions where some of those consumers will go into our brands, but I think they're looking for different propositions. And if you think about Red Bull, Monster, or Rockstar, or some of the other brands that are capturing majority of that space, they have a very different proposition, right? I'm not saying it's not a big business opportunity. I'm saying that, you know, it's not going to be the center of the category, I think. But, you know, more to see in the coming quarters. And, of course, we'll keep thinking about how do we make our brands, our global brands, play in more spaces because that is a very high return on investment normally for us. As you can see with Gatorade Zero or with Pepsi Zero, those are – When you put your big brands into new spaces, that is a huge, huge, huge business opportunity.

Your next question comes from Amit Sharma of BMO Capital.

Hi, good morning, everyone. Morning. Ramon, a question for you. You talked about stronger growth in the convenience store channel as one of the reasons for maybe a little bit more price mix that we saw, especially for the snacks business. Can you talk about that dynamic in terms of online as you grow your online business? Should that also be a price makes positive from a relative contribution perspective? And then the relative size of your business is online at this time.

Yeah, Amit, it's you. What we've said in the past is our online business is over a billion dollars, and generally speaking, it is going to tend towards smaller packages. So it's not going to be the multi-serve. It'll tend towards multi-packs and singles and things like that. So generally speaking, that is going to be a positive from a mixed perspective. Obviously, we're in very early days on online, but my expectation is as that market continues to evolve, it will be both premium and, in all likelihood, more singles and multi-packs.

Your next question comes from the line of Sean King of UBS.

Hi, thanks. I believe you mentioned a few specific reinvestment areas over the last couple quarters, including small can capacity and Frito variety packs. Where do you stand against those specific initiatives, and are you still, I guess, capacity constrained?

Yeah, we're putting capacity against that. I think, as I mentioned before, I think this is going to be a long-term consumer trend. Consumers are looking for variety packs, and consumers are looking for smaller portion packs. So we've put a lot of capacity in place where we're seeing that, you know, the more capacity we put, we still are behind demand in some of those packs in some of the geographies around the world. So we're going to have to keep investing in those formats. And, you know, it's is a great problem to have, I would say, that you have a lot of demand for your business and that you need to put capacity in what are very high-margin parts of your business. So, yes, I think we're putting capacity, but we're saying that the consumer is ready to buy more of our products in those formats. So you'll see more of those CapExes going in the future. So thank you for the time and participation in the call. It's been a very, I think, open and good dialogue. To conclude... We're pleased with our results for the second quarter and for the first half of the year. We're executing well against our key priorities. We remain on track to achieve our 2019 financial goals, and we thank you for the confidence that you've placed in us with your investment. Thank you.

Thank you for participating in PepsiCo's second quarter 2019 earnings conference call. You may now disconnect.

Thank you.