PepsiCo, Inc.

Good morning and welcome to PepsiCo's second quarter earnings question and answer session. Your lines have been placed on listen only until it is your turn to ask a question. 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. Ravi Pamnani, Senior Vice President of Investor Relations. Mr. Pamnani, you may begin.

Thank you, operator. I hope everyone has had a chance this morning to review our press release and prepared comments, both of which are available on our website. Before we begin, please take note of our cautionary statement. We may make forward-looking statements on today's call, including about our business plans and the potential impact of the COVID-19 pandemic on our business. Forward-looking statements inherently involve risks.

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and uncertainties and only reflect our view as of today, and we are under no obligation to update. When discussing our results, we may refer to non-GAAP measures which exclude certain items from reported results. Please refer to today's earnings release in 10-Q, available on pepsico.com, for definitions and reconciliations of non-GAAP measures and additional information regarding our results, including a discussion of factors that could cause actual results to materially differ from forward-looking statements. Joining me today are PepsiCo's Chairman and CEO, Ramon LaGuarta, and PepsiCo's Vice Chairman and CFO, Hugh Johnston. We ask that you please limit yourself to one question. And with that, I will turn it over to the operator for 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. Our first question comes from the line of Dara Mosinian of Morgan Stanley.

Hey, guys. First of all, the format's very helpful, so kudos to your IR team for sort of pioneering this new format on the street. You know, I was hoping for a bit more color on some of the more volatile areas of your business. You obviously mentioned improvements sequentially within the quarter and guided to the organic sales growth acceleration globally in Q3, so... A, can you just give us a better sense of what specifically is driving that? And then B, I was hoping you could spend some time within that just discussing what you're seeing channel-wise in the U.S. beverage business and what you're seeing across snacks and beverages in some of your key emerging markets. Are you expecting pretty linear progress sequentially going forward in terms of improving sales growth or more volatility, particularly with some of the state restrictions cropping back up in the U.S.? ? And just given the developing market, country performance is pretty divergent in Q2. Thanks.

Okay. Good morning, Dara. I hope you're doing well. Listen, let me try and then Hugh will add some comments as well. Listen, as we look around the world, we see a couple of factors that are driving our business. Number one, as you can imagine, is overall mobility in the country, and that is by far the number one factor, and we're monitoring mobility through various means just to understand potential future performance of the business. That's number one. Number two, and that impacts mostly developing markets, is the the universe of stores are opened. What we're seeing in developing markets is that when the infection goes up in the country, there's about 10% to 15% of the stores that close and sometimes even higher, and that drives a lot of the performance. So that's number two. Number three, obviously, is you know, where do people eat most of their meals? And that's related to whether people are working from home or they're not working from home. And so that's a third factor that is impacting, you know, most of the food consumption. So there could be mobility, but then people still have their meals at home. And so those three are the key factors. Obviously, there's a fourth factor that I think will be more important going forward, which is this possible income in the economy, and that's related to unemployment, and that's related to how much money the governments are putting back into the economy. And that hasn't impacted the U.S. yet. It is impacting some of the other countries around the world, as the governments don't have the muscle to put so much money back into the economy. So those four are probably the most critical factors kind of factors that impact the business, and that's what we're modeling for various scenarios as we go forward. So that's kind of from a very macro point of view. Obviously, I said in the last conf call that we had in April that this was not going to be a linear recovery, right? There's going to be a lot of ups and downs, and we're seeing this happening as we speak, right, in the business. You know, you see countries that we thought the pandemic was behind, especially in the Far East, that the pandemic is going back in very local situations, but still impacting both the actual supply chain and also consumer perception, right? We're seeing this here in the U.S., obviously, as we're all familiar with it. So first it was the Northeast. Now it's other parts of the country that are being severely impacted by the infection. And that obviously impacts our organization because we operate within a community, right? And obviously the number of impacted associates in our business is huge. is a consequence of the community infection. So that puts a lot of pressure on our supply chain as well. So hopefully that gives you a sense of the different variables and the fact that this is going to be a roller coaster if you want going forward. I think we're getting much better at managing our supply chain within this complexity. We're hiring more people, we're training more people, we're making sure that you know, we can maintain the supply chain in any circumstance, but it's still, it's pretty complex as you can imagine.

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Your next question comes from the line of Brian Spillane of Bank of America.

Hey, good morning, everyone. And I hope everybody is doing well. So my question is just related to the COVID related expenses in the quarter. And you know, you're at 378 million for the quarter. And I think if I've got it right in the 10 to about 224 million, that was employee compensation expense. So I guess as we're trying to frame the size of the expense in the back half of the year, you know, is 378 a good run rate? And as we're looking at the components of this expense, maybe if you could help us just walk through what we should be looking at as recurring for the next, you know, three or four quarters and what might, you know, fall off. Hugh, you want to try this one?

Yeah, happy to. Okay, Brian. No, Brian, that's not a good run rate going forward. The number going forward will be less than that. It will still be substantial, but nowhere near that number. If you break it into pieces, things like personal protective equipment, that's obviously going to continue. Things like sanitation, that's going to continue. The allowance for doubtful accounts on customers obviously is going to be variable depending on what we learn over time and how the customer base responds to the current environment. Frontline and employee costs will still be there, but that number should be moderated pretty significantly going forward. So we're not kind of getting into piecemeal guidance, but That should give you a little bit of a sense of the types of things that are going to be ongoing and the types of things that ought to diminish pretty significantly.

Yeah, Brian, the most important component, as you can imagine, or factor that impacts this is the number of infected employees that we have, right? And therefore, the quarantine number. I mean, the biggest factor is when you have an employee that has got the virus, or supposed to have the virus, then we quarantine a lot of people. That's the number one driver of cost. And obviously, that will depend on the evolution of the pandemic in different parts of the world. So right now, Hugh, I think, mentioned the, you know, the different components and how we're thinking about it. But obviously, if the pandemic goes up massively, then that cost will go up.

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

Hi, thank you and good morning. I hope you're doing well. And I understand that this is not a straight line and you comment that, you know, obviously the emerging markets is the main question mark, but could you help us understand how you left the second quarter in terms of cadence on the on-premises and convenience and gas? And so I'm just trying to bridge the low single digits in the three quarters that you guided for. Thank you.

Hi, Andrea. Yeah. Yes to... to give you a sense of how the different components I was referring to earlier impact the different channels. Obviously, mobility has a very direct correlation with, you know, small store sales, right? And in the U.S., it's convenience stores. You know, around the world, it's other channels that play that same role. But we see a big correlation between mobility and convenience store or on-premise, sorry, small-channel performance. Obviously, as we went through the quarter, April was very low consumption in that channel. Second half of May, June was an improvement, substantial improvement in that channel. The away-from-home channel is much more complex, right? There's a lot of different... you know, need states that consumers are going after there. And so there we saw also an improvement overall throughout the quarter, but it's still, you know, substantially below last year. I mean, like, like a big number below last year and also different components of the channel with different levels of performance. So you see channels like transportation still very low, Hospitality is still very low, universities closed. You saw restaurants coming back, especially more informal type of restaurants coming back, and more formal restaurants less so. So you see different performances, Andrea, across the different channels. In terms of geography, China came back. pretty quickly, I would say almost in growth in the last part of the quarter. You saw Europe slower, you know, the comeback of both the kind of the small store channel and the away from home channel in Europe was a bit slower. We're seeing it better lately as people are starting to move around Europe and going on vacation to some areas in the south of Europe. So let's see how it evolves now. Obviously, there's less people moving around Europe compared to other years, but it's improved. In the U.S., we saw an improvement, as I said, in May, June, especially everything that had to do with smaller channels. Now let's see how this latest news in the evolution of the pandemic in the south and the west of the country impacts those channels. and the decisions that regulators take in terms of protecting the overall community, right? So that probably gives you a sense of how this is impacting. As we see the pandemic evolving now into Africa, South America, parts of the Middle East, India, you know, we're seeing obviously an impact in the trafficking stores and that drives the business. So it's still very fluid overall. It's an improvement versus the April timeframe for sure, and that's why we're guiding to a small growth in the Q3.

Our next question comes from the line of Kevin Grundy of Jefferies.

Hey, good morning, everyone, and I hope that you're doing well. Ramon, I had a strategy-related question for you specifically around market share because it certainly seems to be an area of greater emphasis under your leadership and, if I'm not mistaken, also taking on a more prominent role in management incentive structure as well. So, you know, with that in context, is that a fair characterization, number one? If so, how do you drive that behavior? How do you intend to prioritize innovation and premiumization and mix to support market share initiatives? And how do you balance that with the potential risk that this push on market share does not devolve into more promotional pricing, like particularly North America carbonated soft drinks, where the industry has gotten away from that behavior now for a number of years? Thank you.

Thank you, Kevin, and that's a good – that's a very good question. Yeah, listen, share of market is being central to our strategy, and it will continue so, right? It has been during the – the pandemic one of the key principles that we have set for ourselves that we're going to try to improve market share. Obviously, we're trying to develop our market share position in a sustainable way. So it's more related to the strength of our supply chain, the strength of our go-to-market execution, our ability to innovate faster into spaces that We see consumer value, our customer relationships, those elements that we think are sustainable, the power of our brands, obviously. And you saw us making a lot of investments in 2019, both in capacity and infrastructure, in stronger brands. We innovated into new spaces. That's helping us. That's helping us navigate better the current situation. and will continue to do so. There's some spaces in the market that I think will determine the share of market of the future. For example, I think e-commerce, if you see the growth of e-commerce, it is going to be quite strategic, I think. Whoever wins in e-commerce now and is able to capture those families that are trying this e-grocery, service for the first time, I think it's going to win those families in the future. So we're investing heavily in trying to be the first in that channel and trying to, and again, the investments that we made in the last few years, last year in particular, are helping us both from the data availability, the agility of our infrastructure to supply those channels, et cetera. So e-commerce is a key area where we think we can gain market share. Second is The strength of our DSD system and our ability to service the stores directly I think is a capability that is quite unique, and it gives us the advantage to keep the supply chain going in spite of all the challenges we're all facing. So that's also an area where we plan to double down. That improves our execution in-store and the inventory in-store, and that is also a sustainable advantage. The third one is brands. And we have, you know, we're seeing consumers going back to, you know, brands that they trust. And we have, you know, quite a lot in many markets that consumers trust. There's, you know, big brands that have been around for some time. We've modernized them. We've kept them relevant to the consumer. And then we're seeing spaces like healthier parts of the market of the consumer demand where we have a lot of beautiful brands as well and we're investing in those brands either the zero propositions in in beverages both pepsi mountain dew gatorade we're investing a lot in those in those parts of the portfolio and they keep growing and also in snacks with brands like of the eden path or smart food or all the simply range or you know, popcorners or whatever. So, I mean, there's a lot of spaces where we think that if we invest in those spaces, we're going to capture market share for the future. The other one we're investing very, I mean, substantial amounts and it's working very well for us is SolarStream, right? SolarStream is a, you know, is a beautiful business for this situation we're living today, you know? So we, you know, consumers don't have to leave their houses. They have perfect choices. We're putting our Pepsi brands in the solid stream model in Europe and it's working very well and we're investing in those. So it's sustainable long-term market share across multiple parts of the value chain that I think is going to give us, you know, a stronger, it's going to make us a stronger company going forward. So that's how we're thinking about share of market and sustainable share of market.

Our next question comes from the line of Bonnie Herzog of Goldman Sachs.

Thank you. Good morning, everyone. I had a question on your price mix of 1.5% in the quarter, which was better than expected, especially for PB&A where your price mix was up 3%. So hoping you could drill down on some of the key drivers of this. I guess I'm trying to understand the strength in your price mix given the negative channel mix shift, and then I assume negative packaging mix. So, you know, was the strong price mix in PB&A a function of lower promos in the quarter? And then really, how sustainable is this, you know, positive price mix going forward, especially in this environment? Thanks.

Hugh, do you want to go on this? Sure. Happy to. Hi, Bonnie. Yeah, price mix at one and a half for the company. Obviously, that That's a complicated number because it's global and sort of incorporates almost everything. Going a little bit deeper on PB&A, I think the primary factors were around less promotional depth than what we had seen in the past. I think frequency is pretty similar, but the depth wasn't quite there. Obviously, supply can... supply chains were a bit constrained in that regard. So it didn't make sense to go as deep. So I think that's the biggest factor.

Our next question comes from the line of Vivian Azar of Cowen.

Hi, thank you. Well, good morning. Well, I appreciate your commentary around investing behind emerging brands and relevant brands like SodaStream and Just hoping for either you or Hugh to comment on the reduction in non-essential advertising and really just reconciling that. It seems like perhaps the COVID recovery is taking longer than perhaps we would have anticipated when you reported earnings a quarter ago. So just curious to hear how you're thinking about that line item. Thank you.

No, advertising is a key component of our strategy, Vivian, and it will continue. You know, we still think that it's critical that we continue to use that lever to drive penetration of the brands and trial and, you know, use the image of the brand. So that hasn't changed at all. There has been a bit of an adjustment, especially in some markets early on in the quarter, because the truth is that... you know, the consumer habits change a lot and we, you know, we modify some of the A&M decisions. We also have become a bit more selective about the type of A&M that we're doing and some of the activities that had lower ROI, we're stopping them and we're putting more money against the initiatives that had more return on investment. So I think we become better, and sometimes a crisis helps to be more selective and to be more impactful and to, you know, kind of generate internal momentum against simplification and against focus against fewer and bigger. And that's what we're trying to do. As you see from our results, it is working quite well. Obviously, balance of the year, we continue to invest as we see the consumers moving around and demand for our products starting to be a bit higher. Yeah, we'll keep investing and, again, not trying to lose that focus on fewer and bigger and trying to minimize the lower ROI initiatives that sometimes we have in what is a very large business. So that's how we're thinking about A&M. Hugh, I don't know if there's anything else from your side.

Yeah, the one thing I wanted to add as well, Ramon, is Vivian, as we've talked about being stronger, part of that has been building some more capability to do A&M in-house. It's got a couple of benefits. One, it improves our speed, and number two, it has proven to be more efficient over time. So we can actually get the same or more value for less money, which is obviously a terrific outcome for the company.

Our next question comes from the line of Lauren Lieberman of Barclays.

Great, thank you. I felt like in the prepared remarks that the tone around cost control and reinvestment was maybe different a little bit different than it was three months ago. Describe it maybe as a little bit more measured, where last quarter you were talking about staying on the attack. Of course, there was strong criteria for ROI. And this quarter, we're talking about, you know, zero-based mindset, earning your budget. So, I guess... By no stretch do I think that you didn't anticipate that the environment was going to be rough. I think that was very clear three months ago, and it's remained as such. But what is it that's really changed in your thinking and your approach then versus now? Yeah, it did feel a bit different, still very proactive, but sort of from a different stance. Thanks.

Yeah, good, Lauren. The idea... you know, the concept of holistic cost management that we put early on, I mean, it was early last year as one of the principles of how we would get stronger. It's a capability we've been, you know, I would say investing and focusing everybody around the company in this concept of holistic cost management, which basically it is the concept that you're referring to, which is you earn your budget every year. And we're trying to be much more granular around the composition of the budget and what really is required now going forward versus what it was required, let's say, last year or two years ago, and going through that process of rethinking the budget every year and reallocating costs against what's going to give us the best return in the year and going forward. So that capability is there. We're emphasizing it more because, obviously, What we're seeing is that there is a, you know, it's a challenging time. We're having to put $500 million of cost in COVID-related expenses. We will have to put some more going forward. So, you know, we have to find ways to fund that, and we have to find ways to continue to invest in our brands and our commercial activities to keep growing and getting market share. So we have to be super selective on where do we put the money. in every single line of the P&L. So we're emphasizing that from the position that every cent has to work for the growth drivers of the company. So that is the principle that is being adopted across the organization in every single market. On the other side, we're seeing that you know, potentially as unemployment goes up in, you know, in several parts of the world, I think companies will have to be much more cautious about, obviously, the resources that we use and how do we use those resources. So I think this capability is going to come very helpful for us, and that's what we're talking about in the sense of Let's be very diligent in how we look at every single line of our budget, how we reallocate those monies into the highest return on investment growth drivers. And with that, I think we'll be successful in getting share of market and driving growth, hopefully flowing that growth back into profits for the sustainability of the company.

Your next question comes from the line of Laurent Rondet of Guggenheim.

Hey, good morning, Raymond and you. And first, congratulations on the very specific initiatives you are taking to address Black Lives Matter. I'd like to focus my question on the energy category. In your prior remarks, you mentioned the bank business was already almost fully transferred to your system. That was much quicker than most expected, so that's great. Could you please tell us what was the retailer's reaction to the push you are making in the energy category and what they expect from PepsiCo? And also regarding Rockstar specifically, how long do you think it would take to re-energize the brand? Thanks.

Yeah, hello, Laurent. Yeah, good question. Listen, yes, we are... You know, we're almost completed with the, you know, the integration of the bank brand into our selling systems. It's been a complex process because bank had, you know, between 250, 300 distributors across the country. So as you can imagine, you know, the details of that transition has been quite exhausting for Kirk and the beverage team. But they've done a great job of integrating that brand. and also the same with integrating Rockstar in parts of the country that we didn't distribute the brand in the past. So that is, I would say by the end of July, that will be almost complete and then we're ready to go. From the customer relationship point of view, I think the customers see us as a very good partner that can bring insights that can bring, you know, activation to the brands that can bring, you know, better store execution, a lot of drivers that we know, you know, we can deliver and will drive growth for the category. So I would say the reception from our retail partners has been very positive and early signals of it is that we're getting support and that we're executing, you know, with Good quality. And the fact that we have now a full portfolio that has Bang, Rockstar, and some of the Mountain Dew brands as an energy offer, it is a positive development for us versus having smaller brands. So we're seeing positive signals. And as we said last call in April, this is very strategic for us. We continue to focus on the three components of the strategy, You know, driving, revitalizing Rockstar, and you will see some news coming out of Rockstar soon, both on the advertising front and the packaging front, reformulation. integrating bank into our business, and there's distribution opportunities and velocity opportunities in some parts of the country, and then moving with more intentionality into spaces of energy that are not well covered, we think, today, and that we can do a better job. Obviously, we continue to be very focused on Starbucks. Starbucks is a critical part of our energy strategy, and triple shot, double shot is booming, and even more now with people at home. We're seeing all those components working for us in the future. We're very optimistic about this part of the business, and certainly there's a lot of energy in our teams to get it done. And the team is doing a fantastic job, by the way.

Our next question comes from the line of Rob Ottenstein of Evercore.

Great. Thank you very much. I'm wondering if you could talk a little bit about how your dialogue with retailers has evolved from March through June, July, how that's changed. Maybe also touch on the various things that you are doing to help retailers get through this and where things are in terms of shelf sets. Most of the spring resets never never really happened, when do you expect that to happen, and how you look positioned for those. Thank you.

Great. Good question. Robert, listen, in our principles, as we started the pandemic, taking care of our associates was priority number one, and taking care of our customers was priority number two, similar to number one. I think that was the focus of the company, trying to even elevate even more the partnership with all our customers across any country around the world. So that is the focus of the teams. I think we've been agile, we've been closer to our partners, we've been transparent with our supply chain challenges in some cases. But I would say, in general, we're getting very positive comments from our partners on how we are talking to them, helping them to stay in stock and on time, driving business for both and evolving for the future of demand, especially around the space of e-commerce that I mentioned earlier that is clearly growing at a very fast pace, faster than we had all forecasted, you know, about half a year ago. So that's the dynamic. We've made some choices in our supply chain to, you know, we've reduced some of the tail of our portfolio. We've discussed that with our partners, the retail partners, and we both agreed that, you know, it's probably the best thing to do to eliminate the less, let's say the smaller SKUs in the portfolio to maximize the best selling SKUs and be in stock. As I said earlier, our DSD system, I think, is a fundamental advantage in the way we're able to service our customers. And I think they appreciate that, that we've made the effort adjusting delivery schedules and increasing delivery schedules to make sure that we keep our brands in stock and we help, obviously, our partners. That is the level of the commitment we have with our partners. And I think the dialogue is in a very good space. And I think this situation will give us a strategic relationship with our partners that I think we had in the past, but it's probably at a higher level today.

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

Yes, great. Thanks. So I know you've sped up your R&D processes considerably over the course of time, but as we think about today's consumer behavior relative to just a few months ago and the difficulty of predicting where we'll be in the quarters ahead, how is that impacting how your teams are thinking about new plans and product introductions, even looking out to 2021? Because I think those plans might differ in a world where we're at home versus in a world where we're on the move. And I guess, is there a way to think about that? Or is it that your cycle times on new products at this point are such that you feel like you can keep pace with the change that we're all going through right now?

Listen, I think we have improved a lot, as you mentioned. We have segmented our innovation processes in different, you know, quick cycle innovations, more lift and shift, more strategic innovation that takes longer. So we have you know, good segmentation of processes across the company and ways of investing and dealing with innovation through different, you know, stage case approvals and everything related to the size and the velocity that we want from each type of innovation. Yeah, the truth is that we're never satisfied enough, right? I mean, so the sense of urgency in anything we do is going up. And, you know, I think we have improving innovation and we want to improve even more. So from that point of view, we'll continue to make the adjustments to some of the process required. In terms of what you're saying, are consumers changing meaningfully, you know, some of their needs? And are we adapting quickly enough I would say there are a few spaces where we're trying to move quickly, immunity being one, and we're seeing that consumers are looking for immunity more. Our juice business is booming, and we think that we can come up with other beverages and even snacks that go against that need. Our snacks business are being part of meals. We're seeing that more and more. Consumers are cooking more at home. And that means that obviously brands like Quaker or some of our Quaker portfolio is being incorporated into meals, but also some of our snacks like Tostitos, obviously Sabra and some other brands are being used for meals, right? Lay's or Ruffles. We're going to, you know, obviously move our advertising and our you know, consumer support in terms of giving them recipes and helping them with solutions that, you know, kind of go incentivize that habit. So, there's a marketing element to this. There's also an innovation element to this in terms of packaging or other solutions that we can help consumers move into that space. So, yes, we're moving quickly. you know, we're never satisfied with our, you know, speed of our capabilities. And if you hear the conversations with our internal teams, speed is a key word now, and we're trying to get better at that. We're trying to be the, you know, as close as we can to start up with the scale of a large company. So that is one of our aspirations. And I think it's going to be a long journey of improvement, but we're in the right direction.

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

Hey, good morning. Hugh, you mentioned a $3 billion full-year e-com or roughly 5% of sales. I guess that doubled in North America in the quarter. How much of that is transitory due to the stay-at-home dynamics, or can some of that continue?

Yeah. Hey, Sean, happy to get in on that one. A couple things. One, just to be clear, that $3 billion number is a retail sales number. It's not a net revenue number for PepsiCo, so you've got to discount it for that. Number two, that is the great question. Not clear at this point. I think a lot of that will be dependent on how much consumers or shoppers find that the experience is very good for them. Out-of-stocks, obviously, is always going to be a big question for them because if you get a lot of out-of-stocks, you have to go to the store anyway, which sort of defeats the purpose. And then the other one is, to the degree that they're paying any kind of an upcharge, is it worth the money? So don't have a real good projection on that right now. We're prepared for it to stay large, and we can manage that well if need be the case, both from an execution perspective as well as from a financial perspective, but not clear at this point.

Ladies and gentlemen, this concludes our question and answer session. I would now like to turn the call back over to Ramon LaGuarta for any closing remarks.

Yeah, thank you, everyone, for joining us today. It's great to hear from everybody and for the confidence you've placed in us with your investments. We hope you'll stay safe and healthy, and we look forward to updating you as the year progresses. Thank you again, and have a great day.

Thank you for participating in PepsiCo's second quarter earnings question and answer session. You may now disconnect your lines and have a wonderful day.