Pepsi Q1 Earnings Conference Call: Full Transcript

Operator:

Good morning and welcome to PepsiCo's First Quarter 2016 Earnings Conference Call. Your lines have been placed on listen-only mode until the question-and-answer session. In order to ask a question or make comment please press star followed one on your touch tone 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.

Jamie Caulfield:Senior Vice President-Investor Relations:

Thank you, Operator. With today are Indra Nooyi, PepsiCo's Chairman and CEO; and Hugh Johnston, PepsiCo's CFO. We'll lead off today's call with the review of our first quarter 2016 performance and full year outlook and then will move onto Q&A. We 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. Statement 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 or references to EPS and operating profit growth or on a core constant currency basis.

All references, free cash flow excludes certain items. In addition references to organic revenue results in this call exclude the impact 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 release and to the investors section of PepsiCo's website under the events and presentations tab. As we discuss today's results please keep in mind that our first quarter comprises the 12 weeks ended March 19 for our North America operations and it is the short quarter for international businesses reflecting the months of January and February for most of our operations outside of North America.

Also please make take note that we have reclassified certain functional support cost from SG&A to cost of sales, prior period amounts have also been reclassified and details are foot noted pages 8, 1 of the Q1 earnings release. These changes do not impact PepsiCo's overall revenue, operating profit, net income or earnings per share.

Now it's my pleasure to introduce Indra Nooyi.

Indra K. Nooyi:Chairman & Chief Executive Officer:

Thank you, Jamie. I am pleased to report that 2016 is off to a good start with very strong operating results in the first quarter. Global snacks organic volume increased by 1.5% and global beverage organic volume increased 3%, the highest rate of quarterly beverage volume growth in three years. We delivered 3.5% organic revenue growth led by high single digit growth in Latin America and AMENA and 4% growth of Frito-Lay North America.

Our five largest segments, Frito-Lay, North America; North American Beverages, Latin America, ESSA and AMENA, each had both positive organic volume growth and positive segment pricing. Core gross margins expanded by 130 basis points, and core operating margins expanded by 165 basis points, driven by the positive net pricing and continued execution of our productivity agenda, including the implementation of our smart spending program.

Core constant currency operating profit grew 12% and core constant currency EPS grew 11%. It is noteworthy that we delivered these results in a volatile and uncertain macroeconomic environment. Most of the developed world outside the United States is grappling with slow growth. GDP growth in developing and emerging markets is also challenged with many D&E markets experiencing significant political unrest and high unemployment.

Key energy-producing countries are dealing with significant budgetary gaps and high levels of local inflation in many of these markets are eroding disposable income and dampening consumer spending. It's a difficult environment indeed. Despite these macro challenges, we performed well. Our developing and emerging markets businesses grew organic revenues 7% with double-digit growth in China, Saudi Arabia, Egypt and Turkey.

In the developed markets, we grew organic revenue by 2%, led by performance in the United States, where we grew revenue 2.5%. In fact, in the first quarter, PepsiCo was once again the largest contributor to food and beverage retail growth in the United States, accounting for more growth than the next 17 largest manufacturers combined. We have performed well because our approach to operating in this environment is and has been to execute well against what we can control and to retool our business models and operating system to cope with what we believe could be sustained volatility and uncertainty. And this is really what we are doing.

First, we have accelerated our innovation agenda utilizing our proprietary demands spaces framework. This has led to our new products being more incremental and has contributed significantly to our overall organic revenue growth. We have increased the efficiency and effectiveness of new product launches by leveraging our global scale. We are more quickly and effectively lifting and adapting successful product launches from one market to another, driving more rapid expansion of our largest brands as we all our future billion dollar brands.

For example, in the first quarter, outside of North America, Lipton ready-to-drink tea grew 10%, Mountain Dew grew volume 9%, Gatorade grew 9%, Naked Juice grew 60%, Sunbites grew 42% and Tea Toast grew 9%.

We've continued to generate strong net price realization even in a sluggish consumer environment through enhanced revenue management capabilities and data analytics. We've introduced new price pack combinations tailored to much more targeted shopper and consumer occasions. For example, in North America over the past five years, we have shifted approximately 6% of our carbonated soft drink volume mix from traditional 2 liter and 12-ounce multi-pack packages to higher margin, more profitable single-serve and alternative multi-serve packages. These efforts have been driving higher net price realization for us and our retail partners.

We have also been future proofing our product portfolio, reshaping it to capitalize on consumers' increasing interest in health and wellness. Just to give you an idea, we track two sets of numbers: First, what we view as everyday nutrition, which includes products that provide positive nutrients like grains, fruit and vegetables and proteins, plus those products that are naturally nutritious like water and unsweetened tea. These products account for almost 25% of our portfolio by revenue.

Second, what we view as guilt-free products. These includes the everyday nutrition products plus diet beverages and other beverages that are below 70 calories per 12-ounces and snacks with low levels of sodium and saturated fat. Guilt-free products account for approximately 45% of our portfolio by revenue.

The growth of our everyday nutrition products which account for a quarter of our global net revenue is outpacing the growth of the balance of the portfolio and we've had a significant amount of activity under way to transform our portfolio. Just to give you a few examples, we have broadened our beverage portfolio to lessen our reliance on colas and today we have the leading non-carbonated beverage portfolio in the United States. In fact, globally, just 12% of our revenues come from trademark Pepsi and less than 25% comes from carbonated soft drinks on a global basis.

We have invested in R&D to create advantage sweetner solutions and lower calorie products and we're aggressively moving our portfolio to package and product combinations with fewer calories. Mountain Dew Kickstart with just 40 calories per 8-ounces, is a great example of our execution in this area. Now in its third year, Kickstart generated more than $300 million in estimated retail sales in 2015, and posted a 34% volume growth in the first quarter of 2016.

We've also been shifting more of our beverage A&M to a lower calorie products in order to accelerate growth in strategically advantaged sub-categories and we have increased the nutritional profile of our snacks and foods through the introduction of products like Smartfood Delights which grew volume over 75% in the first quarter, Reduced Fat Doritos, the top selling Frito-Lay snack brand in schools which grew volume 30% in the first quarter, and gluten-free Quaker Oats just a name few.

Net-net we feel pretty good about our portfolio transformation efforts.

Next, we are building and investing in new capabilities to win in high growth channels. To capitalize on increased out of home food and beverage consumption, we have consolidated our food service resources into one team, enabling us to creatively leverage the breadth of our product portfolio with our customers and consumers.

In the United States, food service now represents approximately 14% of our total revenue and in the first quarter outpaced the growth of the balance of the other channels combined. This year, we will be increasing the out of home availability of our everyday nutrition products, both snacks and beverages, through the targeted placement of approximately 20,000 Hello Goodness vending machines across North America.

Our advertising and marketing has also become more impactful. First, we have stepped up our level of investment from 5.2% of sales in 2011 to 6.3% of sales in 2015. In the first quarter of 2016, our A&M expense increased by a further 65 basis points as a percentage of sales versus the prior year quarter. At the same time, we've increased the effectiveness of our A&M investment by shifting more dollars into consumer-facing working A&M, and by more effectively integrating social and digital media in our marketing campaigns.

We've also accelerated our productivity programs contributing to consistent core margin expansion and providing investment funding for growth initiatives. Since 2012, we have generated approximately $1 billion of annual productivity savings and we are on pace to do so again this year. In addition, we have fully implemented our zero-based smart spending program across the enterprise. We're already seeing significant expense reductions in the areas targeted and our organization is fully mobilized to identify opportunities to drive even greater levels of productivity.

And then we stepped up our marketplace execution by working in creative new ways with that retail partners like unique joint execution of sport and entertainment properties, development of new and innovative merchandising and fountain equipment, execution of coordinated consumer promotions and leveraging the combined power of the PepsiCo product portfolio. So for example, with 7-Eleven, Doritos and Super Bowl all turning 50 this year, in the first quarter, we teamed up to offer consumers NFL experiences and prices, including a trip to Super Bowl 50. When consumers purchase a golden combo of any size Doritos, Pepsi, Slurpee or Grill Item, they could scan this 7-Eleven app to receive a code to unlock prices from teamupforgold. com.

At Albertsons we executed a joint promotion across PepsiCo's entire product portfolio in the all for Super Bowl Sweepstake. It was a massive blitz of in-store displays in circular advertising and online promotions. When consumers purchase two or more participating products in one transaction, they qualify to enter to win $50,000, one of 50 nflshop.com gift cards every week during the promotion period. These examples are by no means the exception to rule. There are just a couple of demonstrations of how we are working creatively and collaboratively to deliver value to the consumer and be an indispensable growth partner for our retailers.

The actions we have taken and the investments we've made to strengthen our capabilities, our innovation, revenue management, portfolio transformation, customer service initiatives in particular is what helped us deliver impressive operating results in the first quarter. We continue to achieve healthy net revenue realization, and new products continue to be an important contributor to our sales growth.

Net, in the context of an interesting macro backdrop, we feel good about the state of our business and we are off to a good start in 2016. We believe we have the right plans in place, we have great people, we are executing well, we are investing in capabilities to propel our future growth, we will continue to leverage our considerable advantages, our scale, geographic presence, product portfolio and power of one synergies to succeed in this environment and we are well positioned to achieve our 2016 financial targets.

Many of our investors have commented me that they value PepsiCo because of our sustained reliable performance. As the stewards of this remarkable 50-plus-year-old enterprise, we are managing and investing in the business to extend the duration of performance, while achieving returns of cost of capital and we are committed to ensuring that our best years are ahead of us.

With that, let me turn the call over to Hugh Johnston. Hugh?

Hugh F. Johnston:Vice Chairman & Chief Financial Officer:

Thank you, Indra and good morning everyone. As Indra mentioned, we are pleased with the financial results for the first quarter and having a good start to the year with one quarter behind us gives us added confidence in achieving the financial targets we shared with you in February. And so as you saw in this morning's release, we reaffirm those targets.

Specifically, we expect approximately 4% organic revenue growth, excluding the impact of the 53rd week and we expect 8% core constant currency EPS growth excluding the impact of deconsolidating our Venezuela operations and 6% when including the Venezuela impact.

Notwithstanding our strong Q1 results, the macro outlook remains highly volatile and uncertain and for this reason we are maintaining a cautious stance on the external factors that influence our business. So balancing a positive view of our execution against a more negative view of the macros, we arrive at the conclusion to keep our revenue and earnings guidance unchanged.

We expect foreign exchange translation to negatively impact both revenue and EPS by approximately 4 percentage points, which is also unchanged from the full year estimate we provided to you last quarter. As a reminder, we base our foreign exchange translation forecast on consensus rates. I know a number of you use spot rates which currently leads you to a less significant impact. Clearly as the year progresses, this gap will resolve itself, but we are holding to our outlook at a negative impact of 4% for the year for both revenue and EPS. As a result, we continue to expect 2016 core EPS of $4.66.

Our outlooks on the other metrics we provide remain unchanged and are set out in this morning's release.

For the analysts on the call, as you update your models, I'd ask that you consider the following factors. We have a more difficult core constant currency operating profit growth comparisons in the upcoming quarters, at Frito-Lay North America and North America Beverages. We anticipate a slower rate of gross margin expansion versus Q1, as we expect raw material inflation, which includes the impact of translate action related foreign exchange for the balance of the year, compared to modest deflation in Q1.

We will continue to investing in our business to drive sustainable long-term growth, including a planned increase in advertising and marketing expense as a percentage of sales for the full year. While we expect lower corporate expenses for the full year, primarily driven by lower pension costs, there will be quarterly volatility in this line item due to timing and you should not expect to see the rate of decline that we had in Q1 for the full year. The reinvestment of the 53rd week benefit will occur over the balance of the year, and finally, we will be lapping Venezuela earnings of approximately $0.03 per share in Q2 and $0.06 per share in the Q3. Taken together, we expect balance of year EPS growth to be disproportionately weighted towards the fourth quarter.

With that Operator, we will take the first question.

Question & Answer

Operator:

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 Mohsenian of Morgan Stanley.

Indra K. Nooyi:

Good morning, Dara.

Dara W. Mohsenian:Morgan Stanley & Co. LLC.:

Hi. Good morning. So obviously a tough macro environment as you've mentioned Indra, and org sales in the quarter was slightly below your full year guidance. So I was just hoping for an update on your level of visibility you can hit 4% organic sales growth for the year, particularly as pricing moderates internationally with less FX pressure and you lapover some of the pricing changes in Potato Chips and beverages theoretically moderates a bit and then also if you could just comment specifically on the North American Carbonated Soft Drink pricing environment, the 1% NAB result is below we saw last year. So has anything changed from a competitive standpoint? Thanks.

Indra K. Nooyi:

Okay. In terms of visibility for balance of the year, again Dara, we can talk about what we control. Our innovation pipeline is looking good. Remember the first quarter is not really the season for international because it's only two months. And so, we're really entering the season now and based on the innovation pipeline, based on the execution capability of our businesses, and knowing what we've sold in to customers around the world both on retail and food service, at this point we feel optimistic about our revenue guidance for the year.

Again, this is based on everything that we can control and based on our assessment of the tough macroeconomic environment as we see it today. So I'd say as the year progresses, we'll know more, but we feel recently optimistic about 4% earnings guidance for the year -- sorry, revenue, pardon me.

Let me now turn to the North American pricing. Again, when we look at one, 1% pricing here, it's really rounded down. It was closer to 1.5. And again, we're just now entering the season. So based on what we've seen in the market base, we actually see quite a lot of discipline in pricing and our hope is that given the dynamics of the CSD category in particular, that there will be continued disciplined based mostly on revenue management and a careful mix management and that's really what we're focused on and our goal is to make sure that we don't do anything crazy on pricing because pricing actions don't really drive volume growth.

So, we are just making sure that we focus on mix management or revenue management to keep getting the positive price realization going through the year.

Hugh F. Johnston:

Dara to be also specific on CSD pricing, IRI show 2.5% CSD pricing for the quarter, LRB was about 1.8%, which is consistent with what we've been seeing. So I think we continue to view that, the pricing environment as quite rational.

Operator:

Your next question comes from the line of John Faucher of JPMorgan.

John Faucher:JPMorgan:

Good morning, Indra. It was interesting, I realize the corporate expense was little more favorable, which you mentioned in the call. But you guys -- we saw a little bit less of an investment in SG&A this quarter versus what we've been let's say over the past year and half and really sense the rebase back in 2012. So can you talk a little bit about where you think you're investment levels are versus where you need to be in the balance between sort of reinvestment in margin expansion as we look out over the next couple of years.

Thanks

Hugh F. Johnston:

Hey, John this is Hugh. I'm not sure exactly how you are measuring less investments in SG&A. So it's probably where the conversation offline on that.

What I can say is number one, A&M was up 65 basis points year-over-year. So we continue to see strong push into A&M. Number two, we do continue to invest in capabilities that enable globalization of best practices and that's having a profoundly positive effect on both the innovation as well as the productivity of the company. What I suspect you, you may be seeing is the impact of smart spending which is off to a very successful start as of late last year and into this year.

Certain of the big buckets that we are focused on smart spending whether it be travel or facilities are actually down by meaningful percentages. So I think what you may be seeing this the net of that reflects a less margin invested in SG&A than you perhaps seen in previous quarters. But I don't want you to think that we are not investing in the brands and we are not investing in capabilities to drive performance we absolutely are..

Indra K. Nooyi:

We are committed increasing A&M, investing in R&D, investing in e-commerce. The capabilities from supply chain so that we can start thinking about the future, data analytics we've got increased investment in every bucket right now.

Operator:

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

Bryan Spillane:Bank of America:

Hey good morning everyone. So just a question about I guess the mix in organic sales growth between volume and price mix and really just in North America and more sort of the question going forward. Right now we're seeing more of a contribution from improved revenue management I guess a price mix and you've supported that with product with advertising. Just how sustainable do you think that is going forward over the next couple of years and I guess my question if just at some point where we need to being to see may be more volume growth in order to sustain that kind of organic sales growth or are we comfortable that we can continue to kind of have mixed view a big component of the organic growth.

Thanks.

Indra K. Nooyi:

Again a Bryan, I think I don't think is a clear answer to that because it's like an accordion we go back and forth. Couple of years you get volume growth and then a couple of years you get more revenue growth because you have more opportunity to do mix management when we premiumize the portfolio for an example, we get more revenue than we do volume, because you get very good price utilization on premium products and right now with the launch of lots of premium beverages and launch of premium products coming out of Frito-Lay we are getting good price utilization on that score. And clearly when you do revenue management even shifting to smaller packages many cans, you don't get much volume lift but you get revenue lift and I think as I look into the future, I think you are going to see some volume growth, you are going to see effective mix management both from a revenue management perspective and the product portfolio itself giving us robust revenue growth.

Couple of years from now let's come back and revisit it, but right now that's the strategy going forward. And then we are very judicious in where we add capacity to make sure that we look at the realities of the volume growth in the marketplace.

Operator:

Your next question comes from the line of Bill Marshall of Barclays.

Bill Marshall:Barclays:

Good morning. Thank you very much.

Indra K. Nooyi:

Good morning, Bill.

Bill Marshall:

I was just curious you've alluded to the tough macro backdrop couple of occasions here two markets in particular that jumped out Brazil and Russia and you've got fairly sizable businesses in both of those markets. I am just curious if you can give us a sense of what you are seeing on the ground, and how your business has been operating maybe compared to the more broader challenges that we have seen from a macro perspective. Thank you.

Indra K. Nooyi:

Brazil is a tough, tough, tough market. I mean it's a its a fundamentally a good market, the population, the demographics are pretty good and when the country performs well things are good. But recently in the last I'd say 12 to 18 months there has been a lot of sales endued problems in Brazil, and then the slowdown in China its clearly has had an impact on Brazil, because Brazil was the commodity supplier to the robust growth in China, and so it's going to take some time for Brazil to get through these issues.

Its own political problems and then of course the global commodity price slump right now. So we are cautious in our approach to Brazil focused more value products and where we can get some premium pricing in we try to get it in but Brazil has been I think globally Brazil is one of the toughest economic situations today.

Even the case of Russia, our core is business is doing quite well, because it's one of those markets where we have a spectacular portfolio, very balanced between all day parts, between good-for-you products, fun for you better for you to wonderful balance of products we have in Russia and the Russian consumers are good consumer and we have a scale business covering all of Russia. I think two issues are impacting Russia, one is the ruble on where it stands, because when you have dollar denominated cost coming into Russia clearly its squeezes the middle of the P&L and you can't price enough to cover all of it, because the Russian consumers which brings into the second point a Russian consumers rages and not going up as much as cost of living bucket suggest it should go up. So there is a bit of squeeze going on. But all things considered our team in Russia is mostly Russian doing a very-very good job navigating thorough these issues and Russia and I must say, fall of these global macro conditions especially the strength of the dollars squeezing cost structure we have a good business in Russia and the team is doing a good job running it right now.

Operator:

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

Indra K. Nooyi:

Good morning, Caroline.

Caroline Levy: CLS

Good morning Indra. Thank you. Question on the charge you took in China if you could just elaborate what's going with -- I saw he beverages and what do you think for the outlook I mean so what goes the charge, what's the environment like in China and what you think the outlook is for your business there.

Indra K. Nooyi:

Yes. So let me start off by saying Caroline that Tingyi it still the leader in the beverage market in China. Still has the most phenomenal infrastructure wildly covers China with all manufacturing technologies cold fill, hot fill, aseptic, water lines you name it they're an amazing scale player and they remain a valuable partner to PepsiCo.

I think Tingyi has been impacted by a couple of three issues and you know there is a public company you've seen all their disclosures and announcements I am not going to share with you anything that you don't know. But basically the slowdown in the Chinese market for beverages overall driven by the macros and some of the operational issues that Tingyi has to cooperate, because of the changes they will making to make their system more efficient has taken a short term hit and performance. And I think the read through has been that we too took a bit of a marginal hit in beverages in our performance. As we've talked about openly in our earnings calls.

But having said that within China we have a very good business in foods and nutrition and our beverage business sequentially is beginning to do better. So we remained cautiously optimistic. As far as our partnership is to Tingyi is concerned look our ownership was based on the price that we recorded when we refer do the transaction since that time the overall Chinese market is come down a lot and secondly, because of Tingyi's own performance, their stock has down quite a bit and so to reframed was prudent to markdown the value of our investment. Having said that we remained very committed to the Tingyi partnership and once they get through their issues which they have to get through we can help them, but its they're the public company.

We will be back to a partnership that continues to sink.

Operator:

Your next question comes from the line of Bill Schmitz of Deutsche Bank.

Indra K. Nooyi:

Hi, Bill.

Bill Schmitz: Deutsche Bank Securities, Inc.:

Good morning. Is it safe to assume that the pricing in emerging markets is going to lap in the back half of the year, and I am just curious for you and the industry kind of what happens when those laps takes place, and then maybe if you could just sort of disaggregate mix benefit versus the price benefit.

Hugh F. Johnston:

Yes, Bill this is Hugh. I think it's safe to assume we will continue to get good solid pricing in those markets. I understand what you are pointing out is as dollar based commodities become less inflationary in local terms, where we continue to get the same level of commodity driven pricing.

We remains to seen part of our pricing is obviously driven by commodities, part of it is driven by what else is happening in the local economy to the degree that pricing is less I do expect that we will see some volume bounce back. Because in those markets when you have emerging consumers that are entering the categories obviously as we take less price we tend to increase adoption more rapidly.

So I think the we probably we will see a bit more volume in a bit less price in developing and emerging markets in the back half of the year, but that remains to be seen that there the outlook as we've talked about earlier is not just not overly positive it's also quite uncertain. Regarding mix versus rate I assume that's in North America beverage question because that's though one to answer globally. About two thirds of the pricing benefit that we saw in the first quarter was rate in about third was mix. So we continue to see good balance in fact if anything we probably got a little bit more rate than we have in getting in the previous quarters.

Operator:

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

Indra K. Nooyi:

Good morning, Judy.

Judy Hong:Goldman Sachs:

Thank you, good morning. So I guess on margin, if I look at the Q1 performance and then the outlook for the balance of the year, it seems like Q1 certainly benefited from very strong margin up margin performance and then may be the balance on the year, you're looking for very little margin expansion. So Hugh I know you went to some of the drives, but if you could elaborate a little bit more just in terms of the Q1 speed and particularly I think Frito had very strong margins and then how sort of that facing were is that balance for the year?

Hugh F. Johnston:

Yes Judy happy to trying to add a bit more on that. As I mentioned during the prepared remarks portion of the script, commodities were a little bit deflationary in Q1 because of the overlaps particularly overlaps around energy prices. Commodities will turn to a bit inflationary in the balance of the year.

So obviously that's a drag down margins. Number two, that we are certainly some timing of expenses particularly as related to corporate expenses as I mentioned that gave us a big tailwind. Corporate expenses overall will be down in 2016, but they will be down at the same rate that you saw on Q1. So for the balance of the year it will spread itself out a bit more evenly.

The net of all of that is I would expect less margin improvement in Q2 and Q3 and then you'll stronger margin improvement again in Q4.

Operator:

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

Indra K. Nooyi:

Good morning, Steve.

Steve Powers:UBS:

Good morning, thanks. I guess two if I could you mentioned to worsening macro assumptions in your outlook versus a few months ago. Could you just talk may be about where those incremental concerns are most focused and then interrupt picking up on your comments on new product innovation. Could you update us on how much of your revenue is driven by new product innovation and whether that differs materially across division and I guess also it was a measure you look at to assess the long gravity of new product contributions I know what is differentiating between short term line extensions and more lasting successes like Kickstart has come to represent.

Thanks.

Indra K. Nooyi:

Go ahead, Hugh.

Hugh F. Johnston:

Yes. So I think the two places where we are probably incrementally less optimistic number one is South America and not Mexico, Mexico is the group quite positive on but the balance of South America obviously is a challenge and then number two is Eastern Europe, Eastern Europe is obviously continuing to be challenged from a GDP perspective and that flows through disposable income year for to consumer spending on our products. The balance I think will probably roughly in line with what we have done.

Indra K. Nooyi:

In terms of new products, Steve typically what we look for is 9% of our revenue growth is come from new products and innovation. That's really what we targeted for ourselves this year and we are running close to that number again. One quarter an innovation for the year does not make so what I am going to give you is what we expect the year to come in at and last year we came very close to that 9% number and typically what we look for within that a sort of a 75% line extensions and would we called refresh innovation, because news drives growth in this category and then 25% we'd like it to be sort of reframe and breakthrough which is new platforms or new substantial new packaging that can take the business to whole new level and again across the world this number varies, but roughly speaking that's what we should for and the thing that --is about Kickstart was a new platform but after couple of years it becomes part of the base of the company and then we have to rely on flavor extensions to continue to drive it and so something that reframe or breakthrough the first year after couple of three years start to go back into base and starts getting countered and refresh. So really how we count innovation is really steps has been launched and it is in the market by these two years and we look at the performance of the business on a rolling basis.

So right now we earning at about 9% and its 75 - 25 refresh versus reframe and breakthrough.

Operator:

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

Indra K. Nooyi:

Good morning, Ali.

Ali Dibadj:Sanford C. Bernstein & Co. LL

Hi, guys. So three quick things if I may one is if you could just tell us about the impact of the deconsolidation of Venezuela on your organic top line growth and maybe in on your margins if any.

So as you are putting it out what was the impact on the organics. Two is if you could give us some more should particularly for investors who remained concerned price rationality coming back in the US I mean clearly it's just Werner Nielsen data one quarter where you said around the down. But can you give us more to those investors about why you think you need to be continue being price rational in the North American market I feel those questions all based for lot hear from you and then third is just thinking you jumping up points if you can characterize the problems there that you described earlier how much of it was kind of macro stock market to broad issues versus kind of PepsiCo Tingyi partnership and that's -- kind of third party type partnership and if that means anything differently in the way you guys view the way you want to distribute on global basis with third and I think specifically for example about Brazil beverage as lows historically and ABI obviously coming together but just broadly as well. Thank for those.

Indra K. Nooyi:

Hugh, you talked want to talk about the impact on Venezuela.

Hugh F. Johnston:

Yes, happy to. Ali revenue on Venezuela was point not meaningful on margins.

Indra K. Nooyi:

Yes. Let me talk about pricing Ali can we talk about what we going to do. Our belief is that it's very important that you really execute price rationally in the market because and you drop the price too much doesn’t drive that much consumption growth, volume growth.

I think but at a point in the market in many of our categories where you can roll the business through premiumisation real innovation, but just a playing a price game does not drive volume growth and it actually destroys value. So that's our strategy and that's the playbook that we are going to execute.

Let me turn Tingyi I think I gave you a pretty complete answer when Caroline ask the question, but let me just add to it. You've seen the Tingyi results, you've heard they call you heard all of the news that comes out of Tingyi. So I am not going to talk about a public company that announced its results for its own. I will just tell you that from my perspective or our perspective give you the macroeconomics high straight role.

I think Tingyi itself is trying to retool itself to become more efficient, and whenever you going to do a transformation or retooling, it is going to be disruption in the business, and finally, the PepsiCo Tingyi partnership is carried on very well and I think it will come right back to where it was intended to be.

The transition where we consolidated distribution systems where we sort out products between PepsiCo oriented distribution system or premium products oriented distribution system versus a value oriented products distribution system that transition is taking a little bit longer and it's a little bit more painful, and I wish it could happen faster, but that's a reality of what we are living with because the slowdown in the macro has not helped either.

So, from a Tingyi prospective as I said we've remained optimistic and we just need to power through this and provides the help in terms of capabilities and knowledge transfer to them so they can get through the difficult period. And I don't think Tingyi is indicate of any problems of the global basis. I tell you something, we have hundreds of partners globally in the beverage business. At any point some percentage of those bottlers go through issues.

That's a shame for any company and this beverage business and the strength of the franchise company is how do you help that bottling entity recover from its issues given that we operate -- and we have a reservoir of capabilities. That's really what we are doing, taking people from our established global, sending them into these bottle of businesses to help them improved their performance. So, I don't see any major red flags here Ali.

Operator:

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

Indra K. Nooyi:

Good morning, Robert

Robert Ottenstein:Evercore ISI:

Hey, thank you. Thank you very much, good morning. Couple of questions, you noted in most the segments that you're starting to face now some operating cost inflation. Is that primarily wage inflation can you give us any more details on that please?

Hugh F. Johnston:

Yes. The biggest factor in that is wage inflation. We are call on we've talked about the past, we have about $28 billion in operating expense roughly half of that is labor and outside the US labor is obviously inflationary and it just based on local inflation rates.

Operator:

Your next question comes from the line of Kevin Grandy of Jeffrey.

Indra K. Nooyi:

Good morning.

Kevin Grandy:Jegffrey:

Question for Hugh on North American profitability and margins there and your line of site for improvement. So is just kind of broader question I was just hoping you could kind of briefly touch on what's the margin ambition at Frito. Can that be a 35% operating margin business overtime quicker which seem like there is a significant opportunity there now without the -- weighing on it can that return to a 30% operating margin business and now it seem like that could happen over a much quicker period of time was that went it down, and then if you could briefly touch on NAB as well which is a bit more difficult given the vertical inflation there with borrower ownership. So any commentary there I am sorry that's a bit broad-based will be helpful.

Thank you.

Hugh F. Johnston:

Yes, happy to do that. As you all know we don't give division specific margin guidance it just gets into a level of granularity and details that's probably more confusing than helpful. That said I would broadly say all of our North American businesses have the potential to continue to see improved margins.

How are they going to do that, number one, it will be through our broad-based supply chain productivity programs, we've continue to take cost out. Particularly moving from the plant to the store we are getting more and more efficient there at operating that distribution network. Number two, smart spending continues to present an opportunity to enhance margins and again that occurs across all of our businesses and number three as Indra pointed earlier, we continue to see a lot of opportunities to premiumize our products with those premium products from good price points and once the products are in the marketplace and the A&M has normalized on those new products you can expect to see those are in premium margins overtime. So again I don't want to get in to specific division level margin guidance, but I do believe that all our North American businesses will continue to see margin improvement overtime.

Indra K. Nooyi:

So with that thank you all for your questions and in closing, let me just say we are all are off to a good start. We have confident that we have the right plans in place and we will continue to execute the best of our abilities. We look forward to updating you on our progress as the year advances.

Have a great day. Thank you.

Operator:

Thank you. That does conclude Pepsico’s first quarter 2016 earnings conference call. You may now disconnect.