Good morning and welcome to PepsiCo’s second quarter 2016 earnings conference call. Your lines have been placed on listen-only until the question-and-answer session. [Operator Instructions] Today's call is being recorded and will be archived at www.PepsiCo.com. It is now my pleasure to introduce Mr. Jamie Caulfield, Senior Vice President of Investor Relations. Mr. Caulfield, you may begin.

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 second quarter 2016 performance and full-year outlook and then we’ll move on to Q&A. We’ve kept our comments brief this morning and intend to conclude the call by 8:45. Before we begin, please take note of our cautionary statement. This conference call includes forward-looking statements including statements regarding 2016 guidance based on currently available information. Forward-looking statements inherently involve risks and uncertainties that could cause our actual results to differ materially from those predicted in such forward-looking statements. Statements made on this conference call should be considered together with cautionary statements and other information contained in today's earnings release and in our most recent periodic reports filed with the SEC. References to organic revenue results exclude the impact of acquisitions and divestitures, structural changes, foreign exchange translation and, for full-year 2016, the impact of a 53rd week. To find disclosures and reconciliations of non-GAAP measures that we use when discussing PepsiCo's financial results, you should refer to the glossary and other attachments to this morning's earnings release and to the Investors section of PepsiCo’s Web site under the Events and Presentations tab. As we discuss today's results, please keep in mind that our second quarter comprises the 12 weeks ended June 11 for our North American operations and the three months of March through May for most of our operations outside of North America. And now, it’s my pleasure to introduce Indra Nooyi.

Thanks, Jamie. I'm pleased to report that our businesses continued to perform well in the second quarter. We had more than 2% organic volume growth in both global snacks and global beverages. While foreign exchange translations continued to pressure our reported revenue results, we delivered more than 3% organic revenue growth led by Frito-Lay North America, AMENA, and Latin America. ESSA delivered operating margin expansion together with increased A&M investment. North American beverages delivered solid net price realization and margin expansion. And Quaker Foods North America had very strong net revenue and operating profit growth. And positive net pricing and continued execution of our productivity agenda, including the implementation of our smart spending program, drove 80 basis points of core operating margin expansion. At the same time, we continued to invest in advertising and marketing, which increased 50 basis points as a percentage of sales in the second quarter. And our performance was well balanced by market type. Our developing and emerging markets businesses grew organic revenue almost 7% for the quarter, with double-digit organic revenue growth in China, Mexico, [indiscernible], and Egypt. And our developed markets growth was led by the United States where we grew revenue more than 2%. In fact, on a standalone basis, Frito-Lay was the largest contributor to growth at retail and gained value share in both salty and macro snacks. North American beverages maintained its value share leadership and possesses five of the ten top beverage trademarks based on dollar sales – Pepsi, Mountain Dew, Gatorade, Lipton, and Starbucks. And Quaker gained almost 1.5 value share points in hot cereal, while accounting for 100% of category retail sales growth. Year-to-date, our results are equally strong. Organic revenue grew 3.4%. Core constant currency operating profit grew 7% and up 9% excluding the impact of de-consolidating…

Thank you, Indra. And good morning, everyone. As Indra mentioned, we’re pleased with the financial results for the first half and we have a positive outlook for our performance for the balance of year. And so, as you saw in this morning's release, we raised our full-year core EPS target to $4.71, which incorporates the following: Underlying core constant currency growth of 9% excluding the impact of de-consolidating Venezuela, a negative 2 percentage point impact of the Venezuela deconsolidation, and a negative 4 percentage point impact from foreign exchange translation based on current market consensus. Our outlooks on the other metrics we provide remain unchanged and are set out in this morning's release. Our efforts to improve working capital continue to yield positive results. Over the past year, we've improved our working capital cash conversion cycle by more than 10 days. For analysts on the call, as you update your models, I ask that you consider the following factors. Foreign exchange translation continues to be a headwind, more heavily skewed to Q3 than Q4. We have more difficult core constant currency operating profit growth comparisons in the second half at Frito-Lay North America. North America Beverages has particularly difficult revenue and operating profit lapse in Q3. We expect low single-digit raw material inflation including the impacts of foreign exchange translation in the second half compared to modest deflation in the first half. We will continue to invest in our business to drive sustainable long-term growth, including an expected increase in advertising and marketing expense as a percentage of sales for the full year. And finally, we will be lapping Venezuela core earnings of approximately $0.06 per share in Q3. Taken together, we expect the balance-of-year core EPS growth to be generated entirely in the fourth quarter. And with that, operator, we’ll take the first question.

Thank you. [Operator Instructions] Our first question comes from the line of Bill Schmitz of Deutsche Bank.

Hi. Good morning.

Morning, Bill.

Hey, can you guys just talk about the sustainability of the great organic growth at Frito and then also the margins which are pretty close to peak? Maybe I’m wrong on this assumption, but I think Frito disproportionately benefited from GES. And I just wondered like kind of what inning we are in baseball terminology on that front and if you still think there’s room for margins to go up there.

Let's talk about the organic growth first, Bill, and then, Hugh, maybe you can chip in on the margin expansion. Look, the macro snack category is a big category. And we’re only playing in the salty snack category expanding into savory snacks. And our goal, if you go back maybe 15 years ago, and we've been consistent in this strategy, we’ve always said, grow the core, add more inch out of the core. We’ve used these words. And that’s what Frito-Lay has been doing, solidify our position in salty snacks and start to step out of the core into other savory snacks and then start to take on other occasions from the overall macro snack category. So all the work we’ve done in demand spaces says that there’s huge opportunity as the world starts to swing more and more towards a liking for savory products. So savory is in and we see amazing opportunities ahead for Frito-Lay to grow its business. Secondly, Frito-Lay has been a mainstream competitor. We haven't played as much in the premium part of the portfolio. And now, we've gotten our game together in the premium side and we’re seeing growth. As I mentioned in the script, the premium part of the portfolio grew four times faster and we’re just getting started. So we see tremendous opportunities for Frito-Lay to grow in the premium side. And I’ll make one final comment, Bill, before Hugh to talk about productivity. The great thing about Frito-Lay is that we’ve got great brands. We’ve got a great innovation capability, but we’ve got an amazing pipeline to the customer and consumer. Our DSE system is a well-oiled machine and we can keep expanding the diameter of that pipeline and it’s really our imagination in terms of what products we can innovate with to put through that pipeline. So with that, Hugh [indiscernible] talk about the margins at Frito.

Yeah, happy to. Good morning, Bill. A couple of comments on margins. And the short answer is, I think Frito-Lay still has lots of margin expansion left in it and can do so in a very defendable, sustainable way. Why do I say that? Number one, it's to build on the commentary that Indra just made. While we are the market leaders in premium, we are relatively underpenetrated compared to where we are in mainstream, and premium does offer very, very attractive margins, particularly as you scale it over time. So I think there's a significant margin uplift there. Number two is in the area of GES, the initiative that we've been working on for a number of years where we shorten the supply chain, deliver product to the customer and ultimately to the consumer much more quickly by going essentially direct from plant to store or going from plant to cross-dock to store. The benefit of that is we, obviously, eliminate a lot of excess cost in the system, and as we take that excess cost out, we are reinvesting some back in premium and we’re delivering some to the bottom line. To use the baseball metaphor that you used earlier, we’re really only in about the fourth or fifth inning on GES. GES has a number of years to run. And in fact, I think the GES impact on the financials are likely to be more profound in the future than they have in the past. And then, the third element to this is this whole area of smart spending. Frito-Lay has absolutely taken the ball and run with smart spending as they always do, but we’re really only right now exploiting four out of what could potentially be about 30 categories in smart spending. So I think smart spending also offers us years of runway to deliver additional productivity. So if you put all of that together, premium, plus GES plus smart spending and combine that with the fact that Frito-Lay’s strong market position gives it the ability to scale things in ways that none of its competitors can, I think we have many years of margin improvement to come and, frankly, significant margin improvement to come in Frito.

I think we should add that the way we’ve executed smart spending makes sure that we create the breathing room, but reinvest back in capabilities to keep this virtuous circle going. And that’s what’s important with our productivity programs.

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

Dara, good morning.

Hi. Good morning. So maybe building on that Frito-Lay margin commentary there, you've seen very strong SG&A leverage if you exclude the increases in A&M spending over the last couple of quarters here, Hugh. As we think about that going forward, is that sustainable going forward? And what's driving that because it is different than what we've generally seen over the past few years?

Yeah. Happy to answer that, Dara. To me, number one, it is absolutely sustainable. We’re able to continue to drive that. Why are we able to continue to drive it? We have invested significantly in streamlining our supply chains. And remember, with PepsiCo, the supply chain doesn't just have cost in cost of goods. There's also a significant piece of it in the selling systems, which fall into SG&A. That's primarily the DSD system. We’ve got lots of room to be more efficient on that. We’re really very much in the early innings on that. Number two, we do continue to streamline the organization. And number three, smart spending is having a significant impact on our SG&A spending. So put together, the combination of making DSD more efficient, making the organization more efficient, and leveraging smart pending, you’re seeing improvements in the non-A&M portion of SG&A that are likely to continue to deliver for number of years.

I want to add something to what Hugh said. Dara, we spend a lot of effort, time, and money on putting in an ERP system when we invested in SAP and we started that way back in 2000 and we've been doing that for the last 10 or 15 years. And putting in an ERP system takes time, takes money, and now we’re beginning to see some of the benefits from that ERP implementation. And as we complete a lot of those implementations, we’re able to take out the costs from those implementations and start to realize the benefits. So it’s streamlining the supply chain, the organization, smart spending, and now the increased leverage from the SAP investment.

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

Good morning, Ali.

Hey, how are you?

Good, thank you.

Good. Hey, I have two questions. One is just trying to get a little bit of a better handle on your earnings guidance raise today. I know, last quarter, a lot of people were kind of thinking about it going up. But this quarter you raise it from 8% to 9%. The top line isn't any different. Productivity is roughly the same. Commodity looks the same. Taxes look unchanged versus last guidance. So you are assuming an acceleration of about 2 points for the back half of the year. Just trying to get a better sense of what gives you that confidence that it's going to go up to 10% for H2. It’s clearly not macros. You knew the Q4 compare. So trying to get a sense there. That’s question one. Question two, and, Indra, don't take this the wrong way at all. In fact, take it very positively. But there continues to be a real thoughtful set of questions from important investors about your future at Pepsi versus, for example, any future presidential administration. And these are real questions. People are really thinking about it. So can you in any way give us some help in clarifying your future interest between business and politics? You’ve done such an incredible job at Pepsi. People are really kind of asking themselves this question. So anyway you can help clarify that debate, whether you know it or not is out there, would be helpful. Thanks.

So, Hugh, go ahead and answer the first question.

Yeah, happy to, Ali. Thank you for the question. We always start the year with a perspective on the macros and on the world that tends to be conservative. When we give guidance, our intention is always to hit it and perhaps beat it. Now that we’re halfway through the year, I think we’ve seen two things. One, the macros are operating in a consistent steady way, so there has not been a deterioration, which, obviously, is to our benefit relative to our expectations. And number two, we do see significant innovation launching in the back half of the year that we’re quite optimistic about. Some of the things you’ve seen more recently that Indra mentioned, whether it's Mountain Dew Black Label, Aquafina Sparkling, 1893, the Simply line at TOSTITOS down at Frito, or Quaker Breakfast Flats, which are doing terrifically well, and INIT coming out of Quaker as well, when you put together all of that innovation, it will have a disproportionate impact in the back half of the year, which is really our cause for optimism in the balance of year. So that's the driver behind the raise at this point.

Ali, on question number two, in the foreseeable future, next several years, I see myself running PepsiCo.

Your next question comes from the line of Mark Swartzberg of Stifel.

Hello, thanks. Good morning, everyone. Two questions on Latin America, if I could, Indra or Hugh. One is, in the quarter, advertising and marketing in the region was up. I believe for the half, it's flat or maybe even down a bit just by the omission of the reference to being up for the first half. So question one is, do you intend for it to be up for the full year? And then question two is, if you take these two large markets of Brazil and Mexico, could you give us a bit of an update on your outlook for each of those two regions because, of course, the conditions and your performance there are quite diverged. I'm just looking for how you are looking at your future performance in those two markets.

Yeah. I’ll just talk about the second and Hugh can talk about the A&M issue. Brazil, all of us have the read the news on Brazil. Brazil is going through a difficult time politically and socially. So they have to work through their issues. Mexico is actually doing well. The strength of the dollar, the increased remittances into Mexico doing well, the country actually is one of the brighter stars in the whole Latin American economy. So we feel good about our business in Mexico. Our teams are performing very well in Brazil in a very difficult environment. And I think what we’re focused on right now is stepped-up execution, making sure we have the right value equation and trying to gain share in a difficult environment and that's really what we’re focused on right now. So a tale of two cities.

Yeah. Happy to jump in on your question regarding A&M, Mark. We’re actually up 80 basis points on A&M year-to-date. So happy to close the loop with you one how you’re calculating the number that you came up with. But the number is actually up 80 basis points year-to-date. We’re not going to get into A&M guidance for the full year. But given that we’re up 80 basis points year-to-date, I’d certainly expect it to be up for the year. And I think that's a reasonable expectation for you and all the investors to run with as well.

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

Thank you. Good morning.

Morning, Judy.

So I have two questions. One is, obviously, you guys have been very disciplined on the capital allocation front and particularly on the M&A side. And I know that your business is, obviously, performing pretty well right now. But kind of how you are assessing that as it relates to maybe even kind of volatile macro-environment, change in consumer environment and given some of the robust multiples that some of these assets are getting fetched for, do you have any views on looking at divesting some of your assets in this kind of environment? And then completely unrelated, so you are bringing back Diet Pepsi with aspartame, so just wanted to get your perspective on kind of lessons learned and then as you think about your diet portfolio, the risk of maybe fragmenting the portfolio even further with different kind of offerings and how you manage that.

I’m going to talk about the second one. And I can also talk about the first. But I'd like Hugh to talk about this because Hugh is my right hand and left hand when it comes to disciplined capital allocation, and so I’d Hugh to talk about that. Let me talk about Diet Pepsi, Judy. You know what’s interesting? If you go and poll consumers today and read all the social media reports, there’s still trepidation about aspartame. There’s no scientific reason for that, but people are somehow worried about aspartame. And when we launched Diet Pepsi aspartame-free, it’s because there was a huge consumer need for that product. What we did not anticipate is that there is a group of consumers that absolutely loved the original Diet Pepsi. And in the cola category, in particular, because it's been optimized over years, people get incredibly fastidious about their products and don't want to have any changes. So rather than remove the aspartame-free, which is still loved by a lot of people – in fact, I tell you, when we announced that we’re bringing back the old Diet Pepsi, the few people who thought aspartame-free was going away wrote me some pretty tough emails. And so, there is a very loyal group that is thrilled that we have an aspartame-free following. So we brought back the original Diet Pepsi in addition to keeping the aspartame-free product, so we could serve all consumers with the products that they love. I think that's going to be net positive for us. Now, let me just say, the marketplace is fragmenting. Forget Pepsi or Diet Pepsi or the cola category, any new category that’s expanding is becoming niche, more fragmented. And that’s why it was important for us to own the distribution system because once you have control over the distribution system, you can pump a lot of niche products through it, all our craft products, all of those are low-volume products. So we have to learn how to handle complexity, not walk away from it. So, Hugh, talk about capital allocation and the portfolio.

Yeah, sure. Happy to, Judy. Let me just start with a bit of historical perspective on this because, obviously, there's lots of activity in terms of people trying to reshape their portfolios right now. Again, as a reminder, we have about a little over a quarter of our portfolio in nutrition. And then if you add in the better-for-you products, it's really – it gets upwards to almost half of our portfolio in terms of the balance that we have right now. We’re also, from a developing and emerging markets perspective, about a third exposed to developing and emerging markets. All of that as a result of transactions that we've executed really over the last decade or even more, whether it's Quaker, Gatorade, Tropicana, Naked Juice, Wimm-Bill-Dann, Izze, we've executed a variety of transactions over the last ten-plus years in order to get the portfolio into a place where it could consistently deliver performance. And frankly, that's what you've seen, is this portfolio now, regardless of economic cycle, regardless of consumer sentiment, regardless of consumer trends in chips, seems to be capable and has been capable delivering good, strong performance throughout all of those shifts. As we look at things going forward, what we’ve said is, we intend to expend something on the order of $500 million a year in tuck-in acquisitions. As those good opportunities emerge, we look at them and we look at them through two lenses. One is a strategic lens around, does it make sense relative to where we think the consumer is going, and second is, obviously, a financial lens, is this good for our shareholders. And you can count on us to continue to do that because we think that's the right way to think about M&A on a go-forward basis. I will also tell you that we look at everything. We’ve looked at everything that has transacted and probably every company that hasn't transacted. And if something transacts and we’re not a part of it, you can very reasonably assume it's because we didn't want to be. So the result of that is, we feel like we’re operating from a position of strength. We feel like we’re in a position right now where we’ll continue to look at things, we’ll do things if they make sense, but the guidance that we’ve given right now is the guidance that makes sense and that's the way we’re thinking about it going forward. Some investors talk about the notion of, sell when everyone's buying and buy when everyone’s selling, we tend to be good stewards of capital and we follow that maxim fairly closely.

Your next question comes from the line of Caroline Levy of CLSA.

Caroline, good morning.

Good morning, Indra and Hugh. Thank you. Actually just to follow up on what you said, Hugh, for clarification, I guess Judy's question had been around a willingness to sell anything and I think you said that when prices are high you are a potential seller. Is that right?

Only if it makes sense to the portfolio, Judy – or Caroline, I’m sorry. Only if it makes sense to the portfolio.

Okay. So then my question was around Diet Pepsi and the Pepsi franchise overall because, Indra, you gave this stunning number that you drive more growth for retailers than the next five companies, large companies combined. In the case of Pepsi and Diet Pepsi, that has not been the case from what I can see. And so, how do you maintain your shelf space, how do you think about strategically moving those in a different direction? Is it through fragmentation or is there something else you need to do because that seems to be one area where you are really losing share?

Okay. I think, Caroline, and we talked about it in the Q1 earnings call, it is critically important that all of you change your frame of reference in the beverage market from cola to CSDs to LRBs. 30 years ago, it was colas. 25 years ago, it was CSDs. 15 years ago, it was CSDs. It's been LRB for the last decade or so. And I think the sooner we can shift our frame of reference, the better it is because just beating a category that is in secular decline, just beating that all the time is not a game to play, that's not a game that is going to guarantee good results. If we play this rich LRB game, multi-category, placing the bets where the growth is and where the consumer is going, I think we’re better off. So my request to you and all of you who are tracking the company in this category, expand your aperture. LRB is the game to play. That’s the game we’re playing and we watch LRB share very, very carefully. That’s the right strategy for any company.

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

Morning, Rob.

Good morning. And thank you very much. Could you give us a little bit more sense on the North American beverage business? It looks like you've got about 2% price mix. Can you give us a little sense about how much of that is headline pricing, how much is channel mix, category mix just so we have a better idea of what's going on there?

Yeah. A couple of things on that, Rob. This is Hugh. Number one, there was more pricing in CSDs than there was in non-carbs. Not a surprise on that. Number two, about half-and-half split between rate and mix. So very comfortable from that perspective. Obviously, our single strategy has been working particularly well and it's giving us what we think is sustainable mix lift [ph] benefit, with lots of runway left to go on it. So, really, the pricing environment right now, is very good. It's very healthy. We feel terrific about where pricing is in North America.

So thank you all for your questions. And in closing, I just want to say to you that we’re pleased with our results for the first half of the year. We believe we have the plans in place to deliver our targets for 2016. We appreciate the trust you’ve placed in us with your investment. We’re absolutely committed to increasing the value of your investment. Thank you.

Thank you. That does conclude today’s PepsiCo’s second quarter 2016 earnings conference call. You may now disconnect.