Jamie Caulfield - PepsiCo, Inc. Indra K. Nooyi - PepsiCo, Inc. Hugh F. Johnston - PepsiCo, Inc..

Lauren Rae Lieberman - Barclays Capital, Inc. Ali Dibadj - Sanford C. Bernstein & Co. LLC Bryan D. Spillane - Bank of America Merrill Lynch Dara W. Mohsenian - Morgan Stanley & Co. LLC Judy E. Hong - Goldman Sachs & Co. Andrea F. Teixeira - JPMorgan Securities LLC Stephen R.

Powers - UBS Securities LLC Laurent Grandet - Credit Suisse Securities (USA) LLC Vivien Azer - Cowen & Co. LLC Robert Ottenstein - Evercore ISI Kevin Grundy - Jefferies LLC.

Good morning and welcome to PepsiCo's First Quarter 2017 Earnings Conference Call. Your lines have been placed on listen-only until the question-and-answer session. 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. With me today are Indra Nooyi, PepsiCo's Chairman and CEO; and Hugh Johnston, PepsiCo's CFO. We'll lead off today's call with a review of our first quarter 2017 performance and full-year outlook, and then we'll move on to Q&A.

We're aware today is a particularly busy reporting day for the CPG sector, so we've kept our comments brief and intend to conclude the call by 8:30. Before we begin, please take note of our cautionary statement.

This conference call includes forward-looking statements, including statements regarding 2017 guidance based on currently available information. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to differ materially from those predicted in such forward-looking statements.

Statements made on this conference call should be considered together with cautionary statements and other information contained in today's earnings release and in our most recent periodic reports filed with the SEC. Unless otherwise indicated, all references to EPS and operating profit growth are on a core constant currency basis.

All references to free cash flow exclude certain items. In addition, references to organic revenue results in this call exclude the impacts of acquisitions and divestitures, structural changes and foreign exchange translation.

To find disclosures and reconciliations of non-GAAP measures that we use when discussing PepsiCo's financial results, you should refer to the Glossary and other attachments to this morning's earnings release and to the Investor section of PepsiCo's website under the Events and Presentations tab. And now, it's my pleasure to introduce Indra Nooyi..

to build a work force that's diverse and inclusive; to provide working caregivers the support and flexibility they need to meet their responsibilities at work and home; to foster learning; and to promote more effective ways to work together.

For example, in North American Beverages, we've declared 2017 to be the year of the frontline leader and launched frontline leader excellence training to our almost 3,000 frontline managers, with topics covering employer advocacy, time management and career building.

And at Frito-Lay, we are piloting innovative programs to address the continuous need for skilled labor by creating a variety of programs aimed at skill development for our current associates as well as partnerships with local technical schools for development of future talent. Our workplace and culture are more than the product of corporate policies.

It also reflects our values, holding ourselves to the highest standards of excellence, speaking with truth and candor and selling only products we can proudly stand behind. And the fifth area is promoting healthier communities wherever we operate.

Although we're thought of as a global enterprise, we are also members of every local community where we do business. Our associates live there, we make our products there and we often source our raw materials there. For all of these reasons, we have a stake in the local communities we serve and we work hard to meet our responsibilities to them.

An important way we contribute to our communities is by creating well-paying jobs, along with the possibility of long, successful careers. We are also doing our part to be a good neighbor in other ways.

For example, in Chicago, for over a decade, we've been the title partner of the largest high school soccer tournament in the U.S., the PepsiCo Showdown. In 2017, there are 216 Chicago area high schools and more than 21,500 student athletes involved in the event, which is built around the theme Make a Difference On AND Off the Field.

Relatedly, there is a monthly community service push with the thousands of PepsiCo Showdown student athletes to cultivate leadership for a brighter future.

And throughout Mexico, our Entrepreneurship for Growth program supports youngsters from vulnerable communities to improve their quality of life, to develop enough soft skills through sport and hard skills through technical education.

So taken together, these steps form a virtuous cycle that's powering our ongoing transformation as a company, enabling us to do well by doing good and positioning us for success, not only over the short term but also over the long term, adding to both the durability and duration of our shareholder value creation.

So net-net, we feel good about the state of our business. We are on track to deliver our full-year financial targets. And we are managing our business to both the short-term and the long-term in a way that delivers healthy, sustainable returns to our shareholders. With that, let me turn the call over to Hugh Johnston.

Hugh?.

approximately $10 billion in cash flow from operations; net capital spending of approximately $3 billion; approximately $7 billion in free cash flow, excluding certain items; cash dividends of approximately $4.5 billion – recall that we previously announced a 7% increase in our quarterly dividend, to begin with the June payment, and this would represent the 45th consecutive year in which we have increased our dividend; and share repurchases of approximately $2 billion.

Finally, as you update your models, I'd like the highlight the following three items as they relate to the second quarter. First, we expect our rate of organic revenue growth to show sequential improvement.

Second, we expect our consolidated core operating margin to contract in the quarter, due to the timing of business investments in Latin America and AMENA. And finally, we expect foreign exchange translation to be a low single-digit headwind on both reported revenue and EPS, based on current market consensus rates.

With that, we're ready to take the first question..

Thank you. Your first question comes from the line of Lauren Lieberman of Barclays..

Morning, Lauren..

Good morning. Thank you. Indra, I found it curious you mentioned you went straight to the tax refund as sort of being an explanation for some of the weakness we've seen in the U.S.

I wonder if you could elaborate a little bit on what you've seen as you've kind of come out of the quarter and maybe anything, frankly, distinctive about your businesses, because outside of Quaker, it certainly looks like snacks and beverages were relatively immune to some of the softness we've seen more broadly across CPG. Thanks..

Thank you, Lauren. Let me just say that, clearly, in the first part of the quarter, several things happened. One is the fact that the New Year build up into the 53rd week of 2016 and then we had the slowdown because the tax refunds were delayed. By the time we got to the end of the first quarter, the business started to pick up again.

So we aren't really concerned. It's just a timing issue. I'd just say globally, our business is looking good. Let me quickly give you a snapshot of what we are seeing globally. Europe is doing very well. It's strong. The return to growth has been impressive, so we are feeling very good about Europe, across all parts of Europe.

The Latin American continent, outside of Brazil, Argentina and Venezuela, is good, but Brazil, Argentina and Venezuela are causes for concern. The Middle East is retooling itself, and we have to wait for it to figure out how they're going to come out of the oil price decline. China, the GDP growth is good.

Our snacks and nutrition business is doing very well, and our beverage business is slowly recovering. And India is coming out of a bold demonetization now to remonetization. There's good GDP growth and we feel good about our business prospects there, too. And as far as the U.S.

is concerned, as we head into the second quarter, we don't have a reason to be worried..

Your next question comes from the line of Ali Dibadj of Bernstein..

Hey, guys..

Morning, Ali..

Hi. So although we've been, obviously, pretty positive on Pepsi for a while and certainly understand the timing shifts you went through just recently, your volume growth in the developed markets wasn't perhaps as great as it could be, certainly not as well as we had expected.

And when we talk to investors and ask about the risks to the company – and I'm not sure it's all manifested in the quarter or not – but the risk to the company longer term, we kind of talk about three things and I'd love your perspective on it. One is Pepsi's business over-indexing to convenience stores in a time where gas prices are up.

Have you seen any of that impact? Two is the company's difficulty, I guess, perhaps inability, to capture impulse purchases online as consumers shift to e-commerce.

And then three is if health and wellness ever really impacts snacks like it does the rest of packaged foods? And have you seen any of those things manifested in the quarter or do you think it's all timing? And I guess also, are those perhaps legitimate concerns more broadly going forward?.

You know, Ali, those are all very good questions, but every one of these concerns can also be reframed as an opportunity. And that's really what we do because if PepsiCo's business is over-developed in C-stores, we look at expanding in grocery and other channels, whether it's foodservice or vending, as a bigger opportunity.

And then we look to see how we can leverage our DSD system to grow our business into new categories in C-stores. And that's what has made us more valuable partners to convenience store retailers. And in terms of difficulty with impulse on online, we've built a very good e-commerce business. It's growing at impressive rates.

I don't want to discuss those rates, but it's growing at impressive rates. And clearly, our challenge is to create impulse online. And we are working on tools with all of our partners to make our categories look like impulse categories online. It's a work in process, but I must tell you that our growth rates are quite impressive.

And in terms of health and wellness and impacting the snacks business, look, snacks are simple pleasures of life. What we are doing is making our snacks more permissible. We're reducing the saturated fat levels. We remove trans fats. We're reducing the sodium levels. If you're going to eat a snack, eat a PepsiCo snack.

And there's nothing wrong with eating a snack that's guilt-free. So our goal is to offer you a range of options from sort of fun-for-you products to guilt-free products, which include Everyday Nutrition, both in a snacking form and in a food-like form.

And at this point, we are singularly focused on growing the core, expanding out of the core but making sure across the board we make them a lot more permissible. And it looks like that strategy is working at this point..

Your next question comes from the name of Bryan Spillane of Bank of America..

Morning, Bryan..

Hey, good morning, everyone. Just a quick question on working capital, Hugh, it looked like it was a use of cash in the quarter.

So can you just give us a little more color on that in terms of just the phasing I guess of cash flow for the year?.

Yeah, Bryan, happy to. We typically are a user of working capital in the first quarter. If you go back, I think you'll see in most years we have generally had a couple hundred million dollar use of working capital, so same here.

What are the drivers? Biggest one is we're starting to build inventory as we get into the hotter seasons, so not atypical in any regard. I think you'll see a pattern that is very, very consistent with what you've seen historically..

Your next question comes from the line of Dara Mohsenian of Morgan Stanley..

Morning, Dara..

Hey. Good morning. So, Hugh, gross margins compressed year-over-year for the second straight quarter. That's a rarity for you guys.

Obviously, you'd highlighted it previously, but I was hoping you could discuss your expectation in the balance of year on gross margins and also give us more detail on what drove the compression in Q1, particularly in terms of the balance between pricing realization versus commodity pressure and the commodity outlook in the balance of the year.

Thanks..

Yeah, happy to, Dara. As you know, we saw some late in the year commodity inflation after a number of quarters of commodity deflation. When I say late in the year, I'm talking about late in the year 2016. That continued into 2017. And we expect that to continue, as we've shared before, over the course of the year.

As you know, our intent is generally to price through commodity inflation. In developed markets, we generally price through 100%.

In developing and emerging markets that have particularly high rates of inflation, we've tended to price through between two-thirds and three-quarters right away and then basically manage the rest of the P&L through productivity. What you saw this quarter, more than anything else, was our pricing in AMENA, in particular, was relatively light.

Couple of markets driving that, the biggest one is Egypt, where we've seen particularly high inflation driven by ForEx. And our pricing is in place such that over the course of the full year, we should see margin appreciation. But in the first half of the year, we will likely see margin compression.

So you'll likely see one more quarter of that, and then you'll see margin appreciation in the back half of the year. That is going to be driven, more than anything, by the fact that in the developing and emerging markets, we'll be taking more pricing to cover the commodity inflation. We do like to balance that out, as you know.

We don't like to sticker shock the consumers in those markets because we want to keep them in the category. So a phased approach to pricing when we see high inflation, we found generally works best for long-term value creation..

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

Morning, Judy..

Good morning. So I wanted to delve a little bit more into the Frito-Lay performance in the first quarter. Obviously, it was more of a price/mix-driven quarter with pretty healthy price/mix and volume down.

So can you just talk about the acceleration in price/mix specifically and what's sort of driving that? And then with Kellogg transitioning out of the DSD system, have you started to see any positive impact on your business? And then, Hugh, just in terms of the currency impact in EBIT or EPS, that actually didn't change, even though revenue numbers came up a little bit, so is it just more of a rounding situation there?.

Yeah, I'll answer the third question first, Judy. It was rounding. So the revenue tipped towards 2% but earnings stayed at 3%, but they both improved directionally, just one tipped over into 2% and the other stayed at 3%.

Regarding the Frito-Lay business, two big numbers to point to that I think both cover the volume and also cover the pricing question that you're asking; the two big factors regarding why volume was down in the quarter, and both are temporary in that regard, number one was the New Year's build.

As Indra pointed out in her opening, New Year's fell into the 53rd week. In the previous year, it fell into Quarter 1 of the year. That cost us about 1.3 points on volume for the quarter. The second was some of the challenges that we had in the Sabra business due to some product challenges, which we're now through and have largely solved.

That cost us about six-tenths of a point on volume for the quarter. Now, one of the things to keep in mind is we don't get revenue credit for Sabra because it's a 50%-50% JV. We get, obviously, volume credit and we get profit credit.

By virtue of that six-tenths of a point coming out of volume but not having an impact on revenue, it probably made it appear that there was more pricing than there is. Net, I think we've got our Frito-Lay pricing in the right place for the year. And as you see the Sabra volume start to come back, you should see improved volume performance.

Obviously, we'll be out of the Easter as well as the New Year's overlap, and the volume will certainly come back because of that. Those were temporary factors, so..

And we're already seeing the volume back..

Absolutely. The exit rate on the quarter is certainly solid..

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

Morning, Andrea. Welcome..

Hi. Good morning. Thank you, appreciate it. Good morning, everybody. Just following up on the gross margin that I had asked, from what I understood is like, obviously, a lot of impacts on the international side, but looking into U.S.

and Frito-Lay and all and the beverage business as well, what could we expect in terms of like should we expect more of a smoother quarters at the balance of the year? Appreciate that, thank you..

Yeah, happy to. So for Beverages, you saw 1% revenue and 3% operating profit growth. I think you will see that strengthen slightly. And then for Frito, you saw 2% revenue and 4% operating profit growth. Again, I think you should expect to see that strengthen slightly as we get into the balance of the year.

Quaker, we certainly expected to see a bit of improved performance. So, I think you'll see all the numbers lift a little bit as we get out of the first quarter and into the balance of the year..

Your next question comes from the line of Steve Powers of UBS..

Morning, Steve..

Hey, thanks. Good morning. Good morning. So picking up on the pricing theme, it was again a pretty large driver of growth organically in Latin America this quarter. And maybe just could just talk a little bit more about how that played out, snacks versus beverages.

But more importantly, looking ahead, do you see that current pricing trend as sustainable, just given some of the comments made by your competitor yesterday, at least with respect to Brazil, as well as the currency reversals we've begun to see since the start of the year? I guess a similar question might relate to Russia and Eastern Europe, as well..

Yeah, I'm happy to handle that one, Steve. We do expect to continue to see solid pricing down in Latin America. A couple things to think about in that regard, our beverage business in Brazil is relatively small, so we are somewhat insulated from some of the commentary that they made.

In addition to that, our biggest business in Latin America is Mexico, where we continue to see very strong performance, both from the beverage business and particularly in our very large snack food business. And then, last but not least, obviously, Argentina has very high rates of inflation.

That does create a significant pricing benefit in our overall numbers. So I do think we'll continue to see somewhat similar results. To the degree that the pricing trends need to moderate because of certain countries, I think you'll see, as you saw last year, improved volume performance.

That's been our history in Latin America is as the pricing comes down from what are visually high single-digit types of numbers, our volume does tend to pick up. So I'm comfortable with the trends. You may see a bit more balance between volume and pricing is all..

Your next question comes....

Sorry. The last question was regarding Russia. Again, I think same answer there. You'll probably see less pricing. The pricing was very ForEx driven anyway.

So to the degree that the Russian consumer economy continues to strengthen, and as ForEx has less of an impact, I think you'll see us take less pricing but you'll see stronger volumes, so you'll probably get a fairly similar revenue result..

Your next question comes from the line of Laurent Grandet of Credit Suisse..

Morning, Laurent..

Good morning, Indra. Good morning, Hugh. Question about Quaker. I mean, despite Quaker being one of the LTS of all (34:54) PepsiCo brands, it seems the top line has been soft for quite some time, now including this quarter. At the same time, operating margin have reached a new high with 27.4% in the quarter.

So could you please give us more color on this business segment and is this first quarter kind of a reflection of what we should see for the entire year?.

Great question, Laurent. I'd say the Quaker business internationally outside the United States is doing very well. Solid growth, we are entering new markets. It's doing very, very well. In the U.S., the Quaker North America numbers that you see includes the Quaker hot cereal, which is where the Quaker brand is housed.

And then all of the other businesses that go within Quaker North America, including Rice-A-Roni, Pasta Roni, Aunt Jemima, there's a whole bunch of other businesses, ready-to-eat cereals. One-third of the business is the Quaker hot cereals. And the Quaker hot cereals business, I'd say, over the past few years, has been flat to very slightly down.

And the only reason why the overall portfolio looks negative is because it's center store business in grocery stores. And the overall center store category is down high single digits, sometimes even low double digits in some quarters.

And so while we are outperforming the center store categories handsomely, I think our next challenge is how do we leverage our relationships with retailers to reinvent center store.

And that's a conversation we've been having with some of the retailers to say how can we help you rethink the center store so that we can bring growth back to that category. And we need to do that in order to bring interest back to that whole cereal aisle and, therefore, Quaker. By itself, Quaker remains a much-loved brand and it's profitable.

And our hope is that with the rejuvenation of center store, our categories grow, too..

Your next question comes from the line of Vivien Azer of Cowen..

Hi. Good morning..

Morning..

So, Indra, the commentary in terms of category trends in North America exiting the quarter is certainly encouraging, but given how much pricing you saw this quarter and how reliant the business has been on pricing for some time now, in particular in Frito, can you talk about the evolution of price elasticity in your categories and whether you're seeing any shift there given some of the nearer-term consumer softness? Thank you..

Yes. I think to talk about elasticity on a category basis is too general, Vivien. I think we look at elasticity sub-segment by sub-segment. And all the pricing we've put in place in the U.S. is very carefully looking at the elasticity curves.

And we look to see what kind of pricing the consumer can adopt, what kind of volume impact it will have and what can we sustain as a portfolio. And I think that what you're seeing right now is pricing that was sensible for the first quarter.

And as the year goes on, I mean, look, we put the pricing in place in Q1, or in fact, I'd say Q4 we started putting the pricing in place, and that's ticking through the year. And we modify that as we go along if we believe that we need to change our promotional calendar to accommodate the consumer trends.

I don't know, Hugh, if you want to add anything..

Yeah, I completely agree with that. And in addition to that, if you look at our pricing in North America, macro top level, it's generally in the 2s, kind of in the low 2% range. And given commodity inflation is low single digits, I think that's sustainable pricing.

Now, the Frito pricing appears a little bit larger than that because of the Sabra conversation that we had earlier, because we were hit on volume and, obviously, it doesn't have an impact on us on revenue.

But as that normalizes, I think you'll see Frito pricing in the 2s, I think you'll see beverage pricing in the 2s and Quaker pricing in the 2s, and I think that's a reasonable place for us to be for the long term. I think that's very consistent with what those businesses can sustain in a modest inflationary environment..

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

Hi, Robert..

Great. Thank you very much. You identified a number of factors that made the first quarter challenging.

One of the things that you didn't mention – I was just wondering if you had any thoughts and observations was did you see any kind of weakness in consumer confidence impacting your results post the election in the Hispanic American community? And overall in terms of the U.S.

business, did you see the tone of business trying to correct for Easter improve? Thank you..

No. No change in tone of business, and I think consumer confidence continues to remain as positive as we've seen it..

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

Morning, Kevin..

Thanks. Good morning. Hey, morning, guys, morning, Indra. Indra, question for you, if I may, on soda taxes. Naturally, seem to be increasing focus. The law passed in Philadelphia, which received a lot of attention and has had a pretty profound impact on entry volumes.

And now we have the vote upcoming in Santa Fe, and then there's reports they have a rather well-known advocate behind such taxes, putting money into that market behind the effort.

So, Indra, hoping to get your updated thoughts there on risk to your business and to the industry; maybe even some historical context for how you view this risk now relative to recent years. Thank you..

one, making our portfolio deliver products that are lower in sugar and a lot of zero sugar products and beverages with positive nutrition. So that's one part of our strategy, and we've been working on that for 10 years. The second part of our strategy, making sure we bolster the rest of the portfolio outside of beverages.

So when taxes do come in, we can cushion the effect through managing the portfolio in a more intelligent way. And that's been our strategy over the last decade because we anticipated some of these trends early on and we started to re-tool the company for that.

So at this point, let me just say that our strategy is crystal clear and we feel comfortable as to where we are headed..

So let me just close by thanking you all for your questions. To summarize, we will continue to manage everything within our control to deliver attractive results in the short-term as we continue to position the business for long-term success.

Thank you all for joining us this morning and, more importantly, thank you for the confidence you've placed in us with your investment. Thank you..

Thank you. That does conclude today's PepsiCo's first quarter 2017 earnings conference call. You may now disconnect..